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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

[X] Annual Report pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934 for the fiscal year ended DECEMBER 31, 1997
-----------------

or

[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from __________ to
__________.

COMMISSION FILE NUMBER 0-22844
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SYLVAN LEARNING SYSTEMS, INC.
-----------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

Maryland 52-1492296
- --------------------------------------------- ------------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)


1000 LANCASTER STREET, BALTIMORE, MARYLAND 21202
- --------------------------------------------- ------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (410)843-8000
---------------

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
- --------------------------------------------- ------------------------
COMMON STOCK, PAR VALUE $.01 NASDAQ

SECURITIES REGISTERED PURSUANT TO THE SECTION 12(g) OF THE ACT: NONE
------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X]. No [ ].

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

The aggregate market value of voting Common Stock held by non-affiliates of
the registrant was approximately $1.2 billion as of March 17, 1998.

The registrant had 29,670,910 shares of Common Stock outstanding as of March 17,
1998.

DOCUMENTS INCORPORATED BY REFERENCE
-----------------------------------

Certain information in Sylvan Learning Systems, Inc.'s definitive Proxy
Statement for its 1998 Annual Meeting of Shareholders, which will be filed with
the Securities and Exchange Commission pursuant to Regulation 14A no later than
April 30, 1998 is incorporated by reference in Part III of this Form 10-K.

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INDEX
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PAGE NO.
--------

PART I.

Item 1. Business............................................. 3
Item 2. Properties........................................... 10
Item 3. Legal Proceedings.................................... 10
Item 4. Submission of Matters to a Vote of Security Holders.. 10

PART II.

Item 5. Market for Registrant's Common
Equity and Related Stockholder Matters............. 11
Item 6. Selected Financial Data.............................. 11
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations...... 16
Item 8. Financial Statements and Supplementary Data.......... 23
Item 9. Changes in and Disagreements With Accountants
on Accounting and Financial Disclosure............. 23

PART III.

Items 10., 11., 12. and 13. are incorporated by reference from
Sylvan Learning Systems, Inc.'s definitive Proxy
Statement which will be filed with the Securities
and Exchange Commission, pursuant to Regulation 14A,
not later than April 30, 1998........................ 24

PART IV.

Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K............................ 24

SIGNATURES


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PART I.
------



ITEM 1. BUSINESS

Sylvan Learning Systems, Inc. ("the Company" or "Sylvan") is the leading
provider of educational services to families, schools and industry. The Company
provides lifelong educational services through three lines of business: the
Sylvan Prometric division delivers computer-based testing for academic
admissions and professional certification programs, and includes the operations
of Wall Street Institute, a European based franchisor and operator of learning
centers for English language instruction that will also administer certain
computer-based testing programs throughout Europe and Latin America; the Sylvan
Learning Centers division provides personalized instructional services to
students of all ages and skill levels and the Sylvan Contract Educational
Services division provides educational services and professional development
through contracts with school systems and other organizations. Sylvan's services
are delivered through its network of more than 3,000 educational and testing
centers around the globe. In 1997, total system-wide revenues were
approximately $395.5 million, composed of $193.6 million from core educational
services ($162.4 million from franchised Learning Centers and $31.2 million from
Company-owned Learning Centers, product sales, franchise sales fees and other
franchise service revenues), $135.3 million from testing services and $66.6
million from contract educational services. Note 21 of the 1997 audited
financial statements contains additional disclosures regarding the Company's
business and geographic segments.


CORE EDUCATIONAL SERVICES: SYLVAN LEARNING CENTERS

Sylvan is widely recognized as providing high quality educational services
with consistent, quantifiable results, and has delivered its core educational
service to more than 1.1 million students primarily in grades three through
eight over the past 18 years. The Company's core educational service segment
provides supplemental instruction in reading, mathematics and reading readiness,
featuring an extensive series of standardized diagnostic tests, individualized
instruction, a student motivational system and continued involvement from both
parents and the child's regular school teacher.

Typically, a parent contacts a Sylvan Learning Center because the parent
believes that his or her child may have insufficient reading or mathematics
skills. Parents learn about Sylvan from the Company's media advertising, from a
referral from another parent or from school personnel. Learning Center
personnel ask the parent to bring the student to the Learning Center to complete
a series of standardized diagnostic tests and to receive educational
consultation. Approximately 35% of phone inquiries result in a visit to a
Learning Center. The Learning Center's Sylvan-trained educators use test results
to diagnose students' weaknesses and to design an individual learning program
for each student. After the initial testing and consultation, the Company
estimates that more than 90% of parents enroll the student in a full course of
study. The program typically requires four to six months to complete and
comprises approximately 36 to 60 hours of instruction. Instruction is generally
given twice a week for one hour per visit. Sylvan requires that all instructors
be certified teachers. The cost of the tests and initial consultation ranges
from $95 to $250, and fees average $35 per hour. The Company estimates that the
typical program costs approximately $1,500.

Learning Centers range from 1,000 to 3,500 square feet. Instruction is given
at U-shaped tables designed to ensure that teachers work with no more than three
students at a time. The student's individualized one hour lesson includes a five
segment mastery approach. There are special incentives, such as tokens
redeemable for novelties and toys, to motivate the student to achieve the
program's objectives and to strengthen the student's enthusiasm for learning.
Personal computers at each Learning Center are used by the student as a
supplemental learning tool. The Learning Center's Director of Education monitors
the progress of each student after each hour of instruction.

Instructors schedule parent conferences after every 12 hours of a student's
program. Throughout a student's course of study, the Learning Center tests the
student using the same standardized diagnostic tests, and the results are shared
with the parents in personal conferences, during which the student's
continuation in a Sylvan program is discussed.

Franchise Operations. As of December 31, 1997, there were a total of 670
Learning Centers in 49 states, five

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Canadian provinces, Hong Kong, South Korea and Guam operated by the Company or
its franchisees. As of that date, there were 460 franchisees operating 622
Sylvan Learning Centers. During 1997, 60 franchised Learning Centers were opened
and five were closed. In addition, during 1997, 13 franchisee-owned Learning
Centers were acquired by the Company. Fewer than 2% of franchisees are currently
more than three months in arrears in the payment of franchise royalties, and the
Company does not believe that the closing of any or all of the Learning Centers
of these franchisees would have a material adverse effect on the Company because
the royalties earned from these franchisees only represented approximately 1% of
total franchise royalties earned by the Company in 1997.

The Company licenses franchisees to operate Sylvan Learning Centers in a
specified territory, the size of which depends on the number of school-age
children and average household incomes in the area. Franchisees must obtain the
Company's approval for the location and design of the Learning Center and of all
advertising, and must operate the Learning Center in accordance with the
Company's methods, standards and specifications. Most Learning Centers are
located in suburban areas and have approximately 10 employees, two of which are
typically full-time employees and eight of which are part-time instructors. The
cost to open a typical franchised Learning Center ranges from approximately
$79,000 to $145,000, including the franchise license fee, furniture, equipment
and an initial supply of certain items required under the Company's franchise
agreement.

The Company actively manages its franchise system. The Company requires
franchisees and their employees to attend two weeks of initial training in
Learning Center operations and Sylvan's educational programs. The Company also
offers franchisees continuing training each year. The Company employs field
operations managers that act as "consultants" to provide assistance to
franchisees in technology implementation, business development, marketing,
education and operations. These employees also facilitate regular communications
between franchisees and the Company.

Sylvan operates a quality assurance review program to maintain the quality of
Sylvan Learning Centers. Sylvan's field operations managers confirm franchisee
compliance with the Company's standards, including training requirements,
exclusive use of approved educational materials and programs, correct
administration of testing materials, proper execution of supervisory procedures,
sufficient time spent in parent/teacher conferences, staffing and Learning
Center appearance. Sylvan's field managers counsel franchisees that fail to meet
the Company's quality or financial performance standards and assist these
franchisees in developing a plan to improve their Learning Centers' performance.
When necessary, the Company assists franchisees in selling their franchises.

The Company believes there is significant potential for additional franchised
Learning Centers both domestically and internationally. A number of territories
with only one Learning Center could support one or more additional Learning
Centers based upon the number of school-age children in the market area. The
Company is actively encouraging existing franchisees in these territories to
open additional Learning Centers. In addition, management has identified at
least 234 territories in North America, primarily in smaller markets, in which
there are no Learning Centers. The Company is actively seeking franchisees for a
number of these territories. Forty-two new territories were sold in 1997.

The Company has sold franchise rights for the operation of Learning Centers in
South Korea, Hong Kong, China, the United Kingdom, Spain and the Philippines.
In pricing international franchise rights, the Company takes into account
estimates of the number of centers that could be opened in an area.

The Company's typical franchise agreement (the "License Agreement") grants a
license to operate a Sylvan Learning Center and to use Sylvan's trademarks
within a specified territory. The franchisee is required to purchase from Sylvan
certain diagnostic and instructional materials, student record forms, parental
information booklets and explanatory and promotional brochures developed by the
Company. Sylvan specifies requirements for other items necessary for operation
of a Learning Center, such as computers, instructional materials and furniture.
The Company currently offers a License Agreement with an initial term of ten
years, subject to unlimited additional ten year extensions at the franchisee's
option on the same terms and conditions. The initial license fee ranges from
$34,000 to $42,000, depending on factors such as the number of school-age
children in the territory. Royalties are either 8% or 9% of gross revenues of
the Learning Center, and the royalty rate depends upon the demographics of the
territory and is specified in the License Agreement. Advertising spending
requirements range from $1,000 to $3,500 per month, or up to 6% of gross
revenues, whichever is greater. The License Agreement has been revised
periodically, and several franchisees are operating under older agreements with
variations from the above terms. Approximately 10% of

4


franchisees operate under older agreements with royalties as low as 6% and
without any requirement to contribute to the national advertising fund. The
remaining 90% of the franchisees are required to contribute a minimum of 1.0% to
1.5% of gross revenues to the national advertising fund. The fund is
administered by the SLC National Advertising Fund, Inc. ("SNAF"). The Franchise
Owners Association ("FOA") owns the SNAF. The FOA is an association whose
members consist of Sylvan franchise owners. Franchisees must submit monthly
financial data to the Company.

Company-owned Learning Centers. As of December 31, 1997, Sylvan owned and
operated 48 Learning Centers: five in Baltimore, seven in Dallas, six in Los
Angeles, five in Orange County, California, six in the greater Philadelphia
area, six in South Florida, eight in the greater Washington, D.C. area and five
in the greater Minneapolis area. The Company's operation of Learning Centers
enables it to test new educational programs, marketing plans and Learning Center
management procedures. As of December 31, 1997, eleven of the Company-owned
Learning Centers contained Technology Centers for computer-based testing.
Company-owned Learning Centers give the Company a local presence in key markets,
which has been helpful in marketing the Company's services to school districts
utilizing Title I funds and to employers interested in the Sylvan-At-Work and
PACE programs (see "Contract Educational Services" on page 7). The Company may
consider selected acquisitions of additional Learning Centers now operated by
franchisees.


SYLVAN PROMETRIC

The Company conducts its testing business through 1,981 testing centers, 1,125
of which are located in the United States and Canada and the remainder of which
are located in 103 foreign countries. These centers are classified as either
Sylvan Technology Centers ("STCs") or Authorized Prometric Testing Centers
("APTCs"). STCs are generally located in certain existing franchisee and
Company-owned and operated sites. During 1997, the Company added 691 testing
centers, of which 617 were APTCs. The Company believes that it can increase
capacity by adding workstations at existing testing centers, as well as by
opening new testing centers. Opening a new testing center can take up to 120
days. Computer-based tests, which can be offered during regular school hours
and on weekends at STCs, increase the utilization of Learning Centers. Testing
also increases the public awareness of Sylvan Learning Centers and the Company's
core educational services.

For STCs, Sylvan provides the supporting infrastructure and administration,
including computer equipment and software systems in each testing center and
where appropriate, registration and scheduling of candidates, downloading of
individual tests and training and certification of STC personnel in accordance
with procedures established by the sponsoring testing organization. The
franchisee provides the space and staffing for the testing center. The Company
enters into contracts directly with the testing organization, such as
Educational Testing Service ("ETS"), under which Sylvan receives a fee based
upon the number of tests given. The Company has entered into a separate
agreement with each franchisee that operates a testing center, whereby the
franchisee receives a fee per test that decreases as the volume of the tests
delivered increases.

APTCs must meet certain criteria established by the Company for administering
computer-based testing and are required to furnish the space, equipment and
personnel needed for their operation and receive compensation for test delivery
in various forms including marketing assistance for their core business.

Principal customers in the information technology ("IT") industry are
Microsoft Corporation and Novell, Inc.. IT customers sponsor worldwide
certification programs for various professionals such as network administrators
and engineers, service technicians, instructors, application specialists and
developers, and system administrators, operators and engineers. Certification
testing for Microsoft and Novell accounted for $39.3 million, or 29%, of Sylvan
Prometric's revenues in fiscal 1997.

ETS, a leading educational testing firm, develops and administers more than
9.0 million tests each year, including the Graduate Record Exam ("GRE"), the
Graduate Management Admissions Test ("GMAT"), The Test of English as a Foreign
Language ("TOEFL"), the National Teachers Exam ("NTE") and the Advanced
Placement Program, sponsored by organizations such as the College Board. The
largest tests administered by ETS are the SAT, of which 2.3 million are given
annually to college-bound students, and the PSAT, of which 1.9 million are given
annually to all students in grade 10 or 11. As one of the largest and most
influential test developers and administrators, ETS is leading the conversion of
tests to computer-based format from pencil and paper versions.

The Company developed a working relationship with ETS as a result of a joint
venture between ETS and a

5


predecessor of the Company in the late 1980s. This relationship facilitated the
Company's entering into a master agreement with ETS (the "ETS Agreement"), under
which the Company is the exclusive commercial provider of computer-based tests
administered by ETS. This exclusivity provision does not apply to the SAT, PSAT
and Achievement Tests that are sponsored by the College Board.

During 1997, the Company recognized approximately $33.2 million, or 25% of
Sylvan Prometric's revenues in fiscal 1997, from services for ETS. The Company
provides testing services through two contracts with ETS to provide services
both in North America and internationally. Sylvan initially signed a contract
for computer-based test delivery in North America in 1993 with a term expiring
in 1999. This North American contract was renegotiated in 1997 and now extends
through 2005. The North American contract continues to provide that Sylvan will
be ETS's exclusive commercial provider of computer-based testing services in
North America, provided Sylvan can provide sufficient capacity to meet candidate
testing demand, in accordance with the criteria set forth in the contract.
Further, the contract provides that the Company will deliver not less than 50%
of ETS's computer-based testing volume (excluding College Board tests) in North
America.

The North American contract also provides that ETS may establish computer-
based test sites (subject to the requirement for 50% of the computer-based
testing volume being delivered by the Company) at three specific ETS locations,
at ETS client specific locations and at test centers located in colleges,
universities and similar institutions. At present, there are approximately 40
ETS operated test sites.

ETS and the Company entered into an international contract for delivery of ETS
computer-based tests in 1994. The terms of the contract stipulate that the
Company will be compensated for its services through a fee equal to approved
costs, plus 10 percent, and the Company recognizes revenue accordingly. The
Company also is reimbursed for its cost of capital and any foreign exchange
losses. During 1997, the Company recognized revenues of approximately $17.7
million under this contract. In return for the cost plus compensation, the
Company is required to establish a network of international computer-based
testing sites and to deliver ETS's computer-based tests. The contract provides
that the Company shall be the exclusive provider of computerized commercial
testing capacity to ETS for all secure testing programs outside North America.
ETS may establish its own test sites only where Sylvan fails to provide
sufficient capacity as defined by the contract or where the Company's costs of
providing the service would be prohibitive. There are no ETS sites for computer-
based testing operated internationally. During 1997, the Company expanded
international testing for ETS to a total of 116 permanent and 30 temporary sites
in 79 countries.

Under the ETS agreements, the Company offers computer-based versions of ETS'
PRAXIS examination, which is used to license beginning teachers, the GRE, which
is used by graduate schools to evaluate applicants, and through a contract with
the National Council of State Boards of Nursing, a computer-based licensing
examination (NCLEX) for registered and practical nurses. In October 1997,
Sylvan and ETS converted the GMAT examination to computer-based delivery on a
world-wide basis.

In addition to the tests offered through its partnership with ETS, the Company
is one of three entities licensed by the FAA to deliver computer-based versions
of various pilot and mechanical licensing tests for private aviation. In
addition to FAA testing, the Company provides testing services for organizations
in many other fields, such as for computer professionals, medical laboratory
technicians and military candidates.

The Company, in December 1996, purchased Wall Street Institute International,
B.V. and it's commonly controlled affiliates (collectively, "WSI"), a European
based franchisor and operator of learning centers where English is taught
through a combination of computer-based and live instruction. Typically, the
instructional programs are approximately nine months to one year in duration.
WSI has more than 200 company-owned and franchised centers in operation
throughout Europe and Latin America.

The 1996 acquisition of WSI is an important step in Sylvan's strategy to
increase its services to the adult education marketplace and to expand
internationally. Sylvan began building a global network for the delivery of
computer-based testing services in early 1994 through an exclusive international
alliance with ETS. In addition to offering the English language programs, WSI
locations will be utilized by Sylvan to administer certain computer-based
testing programs throughout Europe and Latin America, and accordingly is
considered part of the Company's Sylvan Prometric testing division.

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WSI has 82 centers in Spain with the remainder in France, Germany, Italy,
Portugal, Switzerland, Mexico, Chile, and Venezuela. WSI's international
expansion was accomplished by selling Master Licensing agreements, with each
Master Licensor obtaining franchisees to open centers in their development
areas. Sylvan plans to continue this strategy to expand WSI's presence
globally, with a focus on the Middle East, Africa and the Pacific Rim region.

Effective December 1, 1997, the Company purchased Block Testing Services L.P.,
Block State Testing Services L.P. and National Assessment Institute, Inc.,
(collectively "NAI/Block"), commonly-controlled companies engaged in the
business of designing, marketing, selling, distributing and administering paper
and pencil tests for the licensing of individuals. NAI/Block operates 12
regional offices that develop and administer licensing examinations on the
state, county and local municipality level for various industries, including but
not limited to the construction, cosmetology, real estate and medical
industries. These 12 regional offices provide examinations for 41 states, the
District of Columbia and the Virgin Islands. With the acquisition of NAI/Block,
the Company is now providing services to a market that it had not previously
serviced.


CONTRACT EDUCATIONAL SERVICES: PUBLIC AND NON-PUBLIC SCHOOL BASED PROGRAMS
FUNDED BY FEDERAL TITLE I AND STATE-BASED PROGRAMS; EDUCATIONAL INROADS, PACE
AND SYLVAN-AT-WORK

Title I and state-based programs. The federal government and various state and
local governmental agencies allocate funds to local school districts to provide
supplemental remedial education to academically and economically disadvantaged
students. The main program is the Title I (formerly Chapter I) program,
administered by the U.S. Department of Education. Federal law now contains
minimum student performance standards for each school district receiving Title I
funds. The Company believes that because of its proven record of achieving
measurable improvement in the reading and mathematics skills of its students
nationwide, it is positioned to provide supplemental educational services to
school districts receiving Title I and similar state funds. As of December 31,
1997, the Company had contracts to provide supplemental remedial educational
services to the following public schools: 45 Baltimore schools, 12 Chicago
schools, 10 Detroit schools, eight Washington D.C. schools, five St. Paul
schools, four Richmond schools and 25 schools in twelve other school districts.

In January 1998, the Company was awarded a contract to provide supplemental
remedial education services in eight public schools in the district of Compton,
California.

Using Company personnel, Sylvan offers virtually the same core educational
services to students in schools as is offered at Sylvan Learning Centers. The
school designates a classroom to be the Learning Center for the duration of the
contract and modifies the classroom to resemble a typical Learning Center.
Sylvan personnel administer standardized diagnostic tests and, based on the
results, prescribe an individualized learning program for each child. Students
typically receive two hours of instruction per week, which includes the use of
personal computers as in a Learning Center. The Company can provide these
services to students after school, on Saturdays, during the summer or as a
"pullout" program during the regular school day, which is the method currently
prescribed by most current contracts. There is a high degree of individual
attention, with student to teacher ratios of no more than three to one. The
program is designed to include a high degree of parental involvement, and
teachers make a special effort to have the parents involved.

Under most of its contracts, the Company has guaranteed that each student who
receives instruction in the Sylvan program and meets prescribed attendance
requirements will achieve some minimum measure of improvement required by the
school districts, as measured by standardized tests. Improvement is measured
using various standardized measures, including normal curve equivalents
("NCE's") a generally accepted statistical measure of student performance. The
typical minimum improvement required is two NCE's per year. If a student does
not achieve the required improvement, the Company will provide 12 hours of
remedial instruction to that student during the following summer or school year
without charge. The Company has not incurred significant expense related to
this guarantee. Under the contracts, the school districts pay the Company a set
fee for all services, materials and equipment. The contracts have terms of one
to three years, with the latest expiring in June 2001. All of the contracts
contain provisions for cancellation by school district officials based on
funding constraints.

The Company is actively seeking contracts to provide its core educational
program to other school systems, offering to tailor its program to the system's
specific needs, and is in discussions with several other major school districts.
In addition to serving public school students, Sylvan can provide its service to
parochial or private school

7


students through contracts with public school districts. Public school districts
are responsible for administering the Title I funding for the non-public
schools. Because government-funded services to any parochial school students
generally cannot legally be provided in the parochial school, Sylvan offers the
flexibility of conducting the program at a nearby Learning Center, or providing
temporary facilities.

Educational Inroads. On May 30, 1997 the Company acquired by merger all of
the outstanding stock of I-R, Inc. and Independent Child Study Teams, Inc.
(collectively, "Educational Inroads") in exchange for 1,414,000 shares of common
stock. I-R, Inc. and Independent Child Study Teams, Inc. were commonly owned by
two shareholders. Educational Inroads provides remedial and special education
services to public and non-public school systems, with current contracts in New
Jersey, Maryland, Louisiana, Washington D.C. and other school districts.

PACE. In March 1995, the Company acquired The PACE Group ("PACE"), a provider
of educational and training services to large corporations throughout the United
States. Services offered by PACE include racial and gender workplace diversity
training and skills improvement programs such as writing, advanced reading,
listening and public speaking. This acquisition compliments the Company's
Sylvan-At-Work program and extends the core educational services the Company
offers to adults in the corporate workplace. PACE provides educational and
training services, typically on-site, to businesses throughout the United States
and generated $15.6 million in revenues for the year ended December 31, 1997.
Management believes PACE is capitalizing on the trend toward outsourcing of
training services by large corporations. PACE licenses most of these programs
from the individuals who developed them and pays royalties ranging from 5% to
15% of the revenues generated from the programs. These programs are typically
offered on-site from one to several days at a time and are conducted by trained
instructors employed by PACE, or, in some cases, PACE will train the customer's
employees to conduct the programs. Additionally, a corporation may purchase a
site license to offer a particular PACE program. PACE currently has 26 sales
offices throughout the United States and markets the programs locally through
its sales force. PACE customers include Ford Motor Company, IBM, BankOne,
General Motors and AT&T.

Sylvan-At-Work. The Company's Sylvan-At-Work program is a modified version of
Sylvan's core educational service provided to businesses on-site. Programs are
currently offered for Motorola, Inc., at one site in Austin, Texas; for Texas
Instruments Incorporated, at three sites in the Dallas area; and for Lockheed
Martin Energy Systems, Inc., at one site in Tennessee.

The Canter Group. In January 1998, the Company acquired Canter and
Associates, Inc. and Canter Educational Productions, Inc. (collectively, "The
Canter Group" or "Canter"), a leading provider of training, staff development
and graduate courseware for educators. The Canter Group had revenues of
approximately $20.0 million in 1997. This acquisition will allow Sylvan to
continue to expand into the college and university market with a proven course
curriculum.


MARKETING

The Company and its franchisees market Sylvan's core educational service to
parents of school-aged children at all grade levels and academic abilities. Far
beyond tutoring, Sylvan Learning Centers' supplemental education utilizes a
diagnostic and prescriptive approach to address the specific needs of each and
every student. A portion of Sylvan's advertising includes spots on morning and
evening news on the national networks. Sylvan's advertising campaign
demonstrates the benefits of its personalized educational services through
testimonials of actual parents and Sylvan teachers. It positions Sylvan as the
leader in supplemental education and emphasizes Sylvan's high quality
curriculum, personalized attention and positive results: better grades and
improved self-esteem. Franchisees form local cooperatives to collectively
purchase local television and radio advertising and usually supplement their
efforts with local newspaper and direct mail. The company also has additional
marketing support for specific programs, including Reading, Math, Algebra,
Geometry, Study Skills, SAT/ACT College Prep, and Writing.

The Company is actively involved in marketing computer-based testing services
to national and international academic testing organizations, such as ETS, and
licensing and professional certification organizations. The Company's network of
testing centers, centralized registration capability and computer-based testing
experience offers important competitive advantages. The Company markets its
school-based educational services to several public school systems and state
education departments. This marketing effort has been expanded to seek
contracts for both public and non-public schools, where both are administered by
the local public school district.

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Marketing efforts for the PACE programs are focused on large corporations
seeking to outsource their training and educational programs, through PACE's 26
sales offices throughout the United States. PACE's strategy is to offer
solutions to the customer's training needs rather than marketing specific
products.


COMPETITION

The Company is aware of only two direct national corporate competitors in its
core educational services segment: Huntington Learning Centers, Inc. and Kumon
Educational Institute. The Company believes these competitors operate fewer
centers than Sylvan and that these firms concentrate their services within a
smaller geographic area. In most areas served by Sylvan Learning Centers, the
primary competition is from individual tutors. State and local education
agencies also fund tutoring by individuals, which competes with the Company's
core educational services segment.

The Company's contract educational services segment's most significant
competitor remains the public school system itself. Given the unique position of
public education in the United States, the Company believes that educational
reforms implemented directly by school officials will not face the same degree
of public resistance that the Company may face. The Company also competes with
school reform efforts sponsored by private organizations and universities and
with consultants hired by school districts to provide assistance in the
identification of problems and implementation of solutions. The Company is aware
of several entities that currently provide Title I and state-based programs for
students attending parochial and private schools on a contract basis.

Sylvan Prometric also has a small number of direct competitors. These
competitors include organizations that have opened centers to offer specific
computer-based tests under contracts with the administrators of those tests.


GOVERNMENT REGULATION

Title I. Title I school districts are responsible for implementing Title I in
carrying out their educational programs. Title I regulations, as well as
provisions of Title I itself, direct Title I school districts to satisfy
obligations including involving parents in their children's education,
evaluating and reporting on student progress, providing equitable services and
other benefits to eligible non-public school students in the district and other
programmatic and fiscal requirements. In contracting with school districts to
provide Title I services, the Company has become and will continue to be,
subject to various Title I requirements and may become responsible to the school
district for carrying out specific functions required by law. For example, under
the Baltimore City Schools' contract, Sylvan has responsibility for soliciting
parental involvement, introducing program content adequate to achieve certain
educational gains and maintaining the confidentiality of student records. The
Company's failure to adhere to Title I requirements or to carry out regulatory
responsibilities undertaken by contract may result in contract termination,
financial liability, or other sanctions.

Franchise. The sales of franchises are regulated by various state authorities
as well as the Federal Trade Commission (the "FTC"). The FTC requires that
franchisors make extensive disclosure to prospective franchisees but does not
require registration. A number of states require registration and prior approval
of the franchise offering document. In addition, several states have "franchise
relationship laws" or "business opportunity laws" that limit the ability of a
franchisor to terminate franchise agreements or to withhold consent to the
renewal or transfer of these agreements. While the Company's franchising
operations have not been materially adversely affected by such existing
regulation, the Company cannot predict the effect of any future legislation or
regulation.


Trademarks

The Company has a federal trademark registration for the words "Sylvan
Learning Center" and distinctive logo (a reading child), a service mark for the
words "Sylvan Prometric" and various other trademarks and service marks and has
applications pending for a number of other distinctive phrases. The Company also
has obtained foreign registrations of a number of the same trademarks. The
Company's License Agreement grants the franchisee the right to use the Company's
trademarks in connection with operation of the franchisee's Learning Center.

9


EMPLOYEES

As of December 31, 1997, the Company had approximately 3,600 employees, 2,000
of whom were classified as full-time and 1,600 of whom were classified as part-
time. Most of the Company's part-time employees are teachers in school-based
programs, Company-owned Learning Centers and Sylvan-At-Work programs. None of
the Company's employees are represented by a union and the Company considers its
relationship with its employees to be good.


EFFECT OF ENVIRONMENTAL LAWS

The Company is in compliance with all environmental laws. Future compliance
with environmental laws is not expected to have a material effect on the
business.


ITEM 2. PROPERTIES

The Company leases all of its facilities, consisting principally of
administrative office space and Learning Centers and testing sites. The Company
leases approximately 108,000 square feet of space in Baltimore, Maryland for its
administrative offices. In addition, the Company leases approximately 55,000
square feet in Minneapolis, Minnesota for general office space and a
registration center, 27,000 square feet in Woodlawn, Maryland for a registration
center and 14,600 square feet in Baltimore, Maryland for a Logistics Center.
The Company also leases space for the 48 Company-owned Learning Centers in
Maryland, Texas, California, Pennsylvania, Delaware, New Jersey, Florida,
Minnesota and Virginia, ranging from 1,500 to 3,500 square feet per Learning
Center. The Company also leases space for 80 testing centers in areas where
there is no Learning Center franchise. These spaces range from 500 to 3,500
square feet. The Company leases space for 54 international testing sites
ranging from 500 to 5,000 square feet, with the lease terms from three to five
years.


ITEM 3. LEGAL PROCEEDINGS

From time to time, the Company may be a party to routine litigation incidental
to its business. At this time, the Company is the defendant in a legal
proceeding pending in the United States District Court for the Northern District
of Iowa, Civil Action No. C96-334MJM, filed on November 18, 1996 by ACT, Inc.,
an Iowa nonprofit corporation formerly known as American College Testing
Program, Inc. ("ACT"). ACT's claim arises out of the Company's purchase of
contract rights to administer testing services for the National Association of
Securities Dealers, Inc. ("NASD"). ACT has asserted that the Company tortuously
interfered with ACT's relations, contractual and quasi-contractual, with the
NASD, caused ACT to suffer the loss of its advantageous economic prospects with
the NASD and other ACT clients and that the Company has monopolized and
attempted to monopolize the computer-based testing services market. ACT has
claimed unspecified amounts of compensatory, treble and punitive damages, as
well as injunctive relief. The Company believes that all of ACT's claims are
without merit.

At this time the Company is not a party, either as plaintiff or defendant, in
any other material litigation.


ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth
quarter ended December 31, 1997.

10


PART II.
--------


ITEM 5. MARKET FOR REGISTRANTS'S COMMON
EQUITY AND RELATED STOCKHOLDER MATTERS

The Company's Common Stock has traded on the NASDAQ Stock Market since its
initial public offering on December 9, 1993. The Company's trading symbol is
SLVN. The high and low trade prices for 1996 and 1997 for the Company's common
stock are set out in the following table. These prices are as reported by
NASDAQ, and reflect inter-dealer price quotations, without retail mark-up, mark
down or commission and may not necessarily represent actual transactions.

1996 High Low
--------------- ------ ------

1st Quarter $26.17 $18.00
2nd Quarter $27.50 $21.33
3rd Quarter $27.50 $18.67
4th Quarter $33.00 $24.25


1997 High Low
--------------- ------ ------

1st Quarter $37.75 $24.25
2nd Quarter $37.38 $23.88
3rd Quarter $44.50 $32.75
4th Quarter $46.25 $38.00

No dividends were declared on the Company's Common Stock during the years
ended December 31, 1996 and 1997, and the Company does not anticipate paying
dividends in the future.

The number of registered shareholders of record as of March 17,1998 was 326.

During the year ended December 31, 1997, the Company issued 1,104,104 shares
of its common stock that were not registered under the Securities Act of 1933.
On January 28, 1997, the Company issued 434,340 shares to Dr. Luigi T. Peccenini
pursuant to the acquisition of WSI. On February 3, 1997, the Company issued
39,552 shares to Carter Holdings, Inc. for the purchase of six franchised
learning centers. On June 30, 1997, the Company issued 214,000 shares to Sylvan
Learning Foundation as a charitable contribution. On June 30, 1997, the Company
contributed 205,882 shares to IT Training Marketing Company. On June 30, 1997,
the Company contributed 149,059 shares to SLC National Advertising Fund, Inc. On
September 30, 1997, the Company issued 2,450 shares to Harold A. Sakayan for the
purchase of one franchised learning center. On September 30, 1997, the Company
issued 15,557 shares to the shareholders of PMZ Inc. for the purchase of nine
franchised learning centers. On December 10, 1997, the Company issued 21,632
shares to Ralph Celidonio and 21,632 shares to Vince Donohue for the purchase of
a business.


ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

On February 1, 1991, Sylvan Learning Corporation (a predecessor to the
Company) and KEE, Incorporated ("KEE"), a computer training software development
business owned by a group of investors including Messrs. Hoehn-Saric and Becker,
the Co-CEOs of Sylvan, entered into a joint venture by contributing
substantially all of their assets to Sylvan KEE Systems, a Maryland general
partnership (the "Partnership"), each in exchange for a 50% interest in the
Partnership. Messrs. Hoehn-Saric and Becker assumed management responsibility
for the Partnership. The Partnership operated the business through January 26,
1993, when KEE purchased all of Sylvan Learning Corporation's outstanding common
stock.

Following KEE's purchase of the stock of Sylvan Learning Corporation, the
Partnership was dissolved, and all of its assets and liabilities were
transferred to KEE. KEE changed its name to Sylvan KEE Systems, Inc. and later
to Sylvan Learning Systems, Inc., in contemplation of the disposition of the
assets of the KEE division. During 1993, Sylvan sold all of KEE's assets and
liabilities for $2.2 million to Computer Innovations Distribution Inc., which
operates under the name Computerland of Canada and is a subsidiary of SHL
Systemhouse Inc. KEE's business had generated operating losses for all periods
and is presented in the Statements of Operations as a discontinued operation.

The selected statement of operations data for the year ended December 31, 1993
consists of the results of the Partnership for the month of January 1993, plus
the results of Sylvan for the eleven months ended December 31, 1993.

11


The selected financial data for the years ended December 31, 1994, 1995, 1996
and 1997 have been derived from Sylvan's financial statements which have been
audited by Ernst & Young LLP. The financial data should be read in conjunction
with the historical Consolidated Financial Statements and Notes thereto.

On May 30, 1997, the Company acquired by merger all of the outstanding stock
of Educational Inroads. Educational Inroads provided contract educational
services to school districts in New Jersey and several other states. On February
17, 1995, the Company acquired by merger all of the outstanding stock of
Remedial Education and Diagnostic Services, Inc. and READS, Inc. (collectively,
"READS"). READS is based in Philadelphia, Pennsylvania and provides remedial and
education services, psychological, diagnostic and counseling services, career
awareness training, and a variety of consulting services. Services are delivered
under contracts with school districts, county-wide educational agencies and
municipalities in the Eastern United States. During 1994, the Company acquired
by merger all of the outstanding stock of Learning Services, Inc. "LSI") and all
of the outstanding stock of Loralex Corporation ("Loralex"). These companies
owned and operated a total of nine Sylvan Learning Centers located in the
Northeast United States and Florida, respectively. All of these acquisitions
have been accounted for by the Company as poolings-of-interests and,
accordingly, the Company's financial statements have been restated for all
periods prior to these acquisitions to include the results of operations of
Educational Inroads, READS, LSI and Loralex. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Background." The
selected statements of operations data include the operations of certain
acquired businesses accounted for using the purchase method of accounting from
the date of the respective acquisition, as further described in the notes to the
accompanying schedule of Selected Consolidated Financial Data.

12


SELECTED CONSOLIDATED FINANCIAL DATA (1)



PARTNERSHIP
AND SYLVAN
COMBINED SYLVAN
--------------- ------------------------------------------------------
YEAR YEAR YEAR YEAR YEAR
ENDED ENDED ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1993 1994 1995 1996 1997
-------------- ------------ ------------ ------------ ------------
(THOUSANDS, EXCEPT PER SHARE DATA)

STATEMENTS OF OPERATIONS DATA:

Revenues:......................................... $51,519 $ 68,748 $ 111,059 $ 181,936 $ 246,212

Cost and expenses:
Direct costs.................................... 44,056 60,388 96,708 150,449 206,621
General and administrative expense.............. 6,255 4,998 6,206 8,755 20,468
Loss on impairment of assets.................... -- -- 3,316 -- 4,000
------- ------- -------- -------- --------
Total cost and expenses...................... 50,311 65,386 106,230 159,204 231,089
------- ------- -------- -------- --------
Operating income................................ 1,208 3,362 4,829 22,732 15,123
Non-operating income (expense).................. (116) 224 391 363 27,974
Interest income (expense), net.................. (1,290) (62) (1,440) 551 2,401
------- ------- -------- -------- --------
Income (loss) from continuing operations
before income taxes and extraordinary
items.......................................... (198) 3,524 3,780 23,646 45,498
Income taxes.................................... (7) (76) (209) (8,850) (16,064)
------- ------- -------- -------- --------
Income (loss) from continuing
operations before extraordinary items.......... (205) 3,448 3,571 14,796 29,434
Discontinued operations (2):
Loss from operations, net of tax.............. (375) -- -- -- --
Gain on disposal.............................. 580 -- -- -- --
------- ------- -------- -------- --------
Income from discontinued operations........... 205 -- -- -- --
------- ------- -------- -------- --------
Net income before extraordinary items........... -- 3,448 3,571 14,796 29,434
Extraordinary items (3)......................... (177) -- -- -- --
------- ------- -------- -------- --------
Net income(loss).............................. $ (177) $ 3,448 $ 3,571 $ 14,796 $ 29,434
======= ======= ======== ======== ========

Earnings (loss) per common share, basic (4):
Income (loss) from continuing operations
before extraordinary items.................... $(0.03) $0.24 $0.24 $0.64 $1.09
Income from discontinued operations............ 0.03 -- -- -- --
Extraordinary items............................ (0.03) -- -- -- --
------ ----- ----- ----- -----
Earnings (loss) per common share, basic.......... $(0.03) $0.24 $0.24 $0.64 $1.09
====== ===== ===== ===== =====

Earnings (loss) per common share, diluted (4):
Income (loss) from continuing operations
before extraordinary items..................... $(0.03) $0.21 $0.21 $0.60 $1.03
Income from discontinued operations............. 0.03 -- -- -- --
Extraordinary items............................. (0.03) -- -- -- --
------ ----- ----- ----- -----
Earnings (loss) per common share, diluted........ $(0.03) $0.21 $0.21 $0.60 $1.03
====== ===== ===== ===== =====

Shares used in computation (4):

Basic........................................... 6,448 14,522 15,132 23,029 26,886
======== ====== ====== ====== =======

Diluted......................................... 6,448 16,286 17,079 24,586 28,538
======== ====== ====== ====== =======

BALANCE SHEET DATA (AT PERIOD END):
Cash and cash equivalents......................... $11,499 $ 4,366 $ 2,903 $ 11,198 $ 23,150
Available-fore-sale securities.................... 1,248 2,537 30,735 16,449 82,926
Net working capital............................... 12,665 13,166 39,407 29,603 113,453
Intangible assets and deferred contract costs..... 7,000 7,932 82,849 122,932 194,576
Total assets...................................... 42,003 50,046 174,070 259,590 475,754
Long-term debt and capital leases................. 6,640 9,814 9,854 32,228 73,328
Stockholders' equity.............................. 24,563 32,481 137,148 180,323 340,371

(footnotes on next page)

13


(1) Prior to February 1, 1991, the Sylvan Learning Centers business was
conducted by Sylvan Learning Corporation (the "Predecessor"). On February 1,
1991, the Predecessor contributed the Sylvan Learning Centers business to
Sylvan KEE Systems, a Maryland general partnership (the "Partnership") in
exchange for a 50% partnership interest, and Sylvan contributed its computer
training software development business to the Partnership in exchange for
the other 50% partnership interest. On January 26, 1993, Sylvan acquired the
Predecessor and dissolved the Partnership. On September 3, 1993, Sylvan sold
its computer training software development business.


During 1994, Sylvan acquired by merger all of the outstanding stock of
Learning Services, Inc. ("LSI") and all of the outstanding stock of Loralex
Corporation ("Loralex"). These companies owned and operated a total of nine
Sylvan Learning Centers located in the Northeast United States and Florida.
On February 17, 1995, Sylvan acquired by merger all of the outstanding stock
of Remedial Education and Diagnostic Services, Inc. and READS, Inc.
(collectively, "READS"), a Philadelphia-based provider of remedial,
education and a variety of consulting services to school districts, county-
wide educational agencies and municipalities in the Eastern United States.
The READS, Loralex and LSI acquisitions have been accounted for by Sylvan as
poolings-of-interests and, accordingly, Sylvan's financial statements have
been restated for all periods presented to include the results of operations
of READS, Loralex and LSI.

Effective September 30, 1995, Sylvan acquired Drake Prometric, L.P.
("Drake"), a leading provider of computer-based certification, licensure and
assessment testing. The transaction was accounted for using the purchase
method of accounting, and Sylvan's results of operations from October 1,
1995 include the operations of Drake.

Effective December 1, 1996, Sylvan acquired Wall Street International, B.V.,
and its commonly controlled affiliates (collectively "Wall Street"), a
European-based franchisor and operator of learning centers that teach the
English language. This transaction was accounted for using the purchase
method of accounting and Sylvan's results of operations from December 1,
1996 include the operations of Wall Street. Sylvan paid $4.9 million of the
$20.1 million purchase price in cash and the remainder in 714,884 shares of
Common Stock.

On May 30, 1997, the Company consummated its acquisition by merger of all
the outstanding common stock of Educational Inroads. Educational Inroads
provides contract educational services to school districts in New Jersey and
several other states. The Educational Inroads acquisition has been accounted
for by Sylvan as a pooling-of-interests and, accordingly, Sylvan's financial
statements have been restated for all periods prior to the acquisition to
include the results of operations of Educational Inroads. Educational
Inroads generated revenues of $24.8 million in 1996.

Effective December 1, 1997, the Company purchased the assets and liabilities
of Block Testing Services L.P. and Block State Testing Services L.P. and
also acquired all of the outstanding common stock of National Assessment
Institute, Inc., (collectively, "NAI/Block"), commonly controlled companies
engaged in the business of designing, marketing, selling, distributing and
administering paper and pencil tests for the licensing of individuals. The
acquisition, which was paid for by issuing 642,901 shares of common stock
valued at $24.6 million in January 1998, was accounted for using the
purchase method of accounting, and Sylvan's results of operations from
December 1, 1997 include the operations of NAI/Block.

(2) Represents Sylvan's computer training software development business which
was sold in September 1993 and a Canadian computer testing business, 80.1%
of which was sold in 1992.

(3) Represents the $350,000 gain on extinguishment of a $3.5 million debt to
Learning Centers, Inc., and a $527,000 loss on an extinguishment of $5.0
million of notes payable to stockholders, each recorded in 1993.

(4) In 1997, the Financial Accounting Standards Board issued Statement No. 128,
Earnings Per Share ("Statement No. 128"). Statement No. 128 replaced the
calculation of primary and fully diluted earnings per share with basic and
diluted earnings per share. Unlike primary earnings per share, basic
earnings per share excludes any dilutive effects of options, warrants and
convertible securities. Diluted earnings per share is very similar to the
previously reported fully-diluted earnings per share. Earnings per share
amounts for all periods have been

14


presented, and where appropriate, restated to conform to the Statement No.
128 requirements.

In February 1998, the SEC issued Staff Accounting Bulletin No. 98 ("SAB No.
98"), which redefined "cheap stock" for registrants completing initial
public offerings of their common stock. The 1993 earnings per share amount
has been restated to conform to the requirements of SAB No. 98.

15


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS


ALL STATEMENTS CONTAINED HEREIN THAT ARE NOT HISTORICAL FACTS, INCLUDING BUT NOT
LIMITED TO, STATEMENTS REGARDING THE ANTICIPATED IMPACT OF UNCOLLECTIBLE
ACCOUNTS RECEIVABLE ON FUTURE LIQUIDITY, EXPENDITURES TO DEVELOP LICENSING AND
CERTIFICATION TESTS UNDER EXISTING CONTRACTS, THE COMPANY'S CONTINGENT PAYMENT
OBLIGATIONS RELATING TO THE DRAKE ACQUISITION, FUTURE CAPITAL REQUIREMENTS,
POTENTIAL ACQUISITIONS AND THE COMPANY'S FUTURE DEVELOPMENT PLANS ARE BASED ON
CURRENT EXPECTATIONS. THESE STATEMENTS ARE FORWARD LOOKING IN NATURE AND INVOLVE
A NUMBER OF RISKS AND UNCERTAINTIES. ACTUAL RESULTS MAY DIFFER MATERIALLY. AMONG
THE FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY ARE THE
FOLLOWING: CHANGES IN THE FINANCIAL RESOURCES OF THE COMPANY'S CLIENTS; TIMING
AND EXTENT OF TESTING CLIENTS CONVERSIONS TO COMPUTER-BASED TESTING; AMOUNT OF
REVENUES EARNED BY THE COMPANY'S TESTING OPERATIONS; THE AVAILABILITY OF
SUFFICIENT CAPITAL TO FINANCE THE COMPANY'S BUSINESS PLAN ON TERMS SATISFACTORY
TO THE COMPANY; GENERAL BUSINESS AND ECONOMIC CONDITIONS; AND OTHER RISK FACTORS
DESCRIBED IN THE COMPANY'S REPORTS FILED FROM TIME TO TIME WITH THE COMMISSION.
THE COMPANY WISHES TO CAUTION READERS NOT TO PLACE UNDUE RELIANCE ON ANY SUCH
FORWARD LOOKING STATEMENTS, WHICH STATEMENTS ARE MADE PURSUANT TO THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995 AND, AS SUCH, SPEAK ONLY AS OF THE
DATE MADE.


OVERVIEW

Sylvan generates revenues from three business segments: core educational
services which primarily consist of franchise sales, royalties and Sylvan-owned
Learning Center revenues; testing services, which consist of computer-based
testing fees paid to Sylvan and the operations of WSI; and contract educational
services, which consist of revenues attributable to providing supplemental
remedial education services to public and non-public schools and major
corporations. The following selected segment data is derived from the Company's
audited consolidated financial statements.



YEAR YEAR YEAR
ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1996 1997
------------ ------------ ------------

Operating revenue:
Core educational services.................. $ 26,063 $ 36,799 $ 44,289
Contract educational services.............. 50,430 58,186 66,582
Testing services........................... 34,566 86,951 135,341
-------- -------- --------
Total revenue............................. 111,059 181,936 246,212
-------- -------- --------

Direct costs:
Core educational services.................. 18,675 25,557 36,708
Contract educational services.............. 47,685 53,373 56,057
Testing services........................... 30,348 71,519 113,856
-------- -------- --------
Total direct costs........................ 96,708 150,449 206,621
-------- -------- --------


RESULTS OF OPERATIONS

Comparison of results for the year ended December 31, 1997 to the year ended
December 31, 1996.

Revenues. Total revenues increased by $64.3 million, or 35%, to $246.2
million for the year ended December 31, 1997, compared to the same period in
1996. This increase resulted from higher revenues in all business segments --
core educational services, testing services and contract educational services.


Core educational services revenues increased by $7.5 million, or 20%, to
$44.3 million for 1997. Franchise royalties increased $1.9 million or 17%, for
1997. This increase in franchise royalties was due to an overall 10%

16


increase in revenues at existing Learning Centers open for more than one year
combined with a net increase of 60 new Learning Centers opened in 1997.

Franchise sales fees increased by $1.3 million, or 43%, to $4.5 million for
the year ended December 31, 1997 compared to the same period in 1996. For the
year ended December 31, 1997, there were six area development agreements sold
for $2.9 million and 42 franchise Center licenses sold, as compared to 38
franchise Center licenses and four area development agreements sold for $1.7
million in the same period in 1996. Product sales decreased by $190,000, or 5%,
to $3.7 million for 1997.

Revenues from Company-owned Learning Centers increased by $4.2 million, or
22%, to $22.7 million during 1997. Revenue growth related to student enrollment
increases for Centers operating over 12 months as of December 31, 1997 resulted
in $4.0 million, or 24%, of the increase for 1997 compared to 1996.
Approximately $1.1 million of the revenue increase resulted from the acquisition
of thirteen centers from five franchisees.

Contract educational services revenue increased by $8.4 million, or 14%, to
$66.6 million for the year ended December 31, 1997. Revenue from public and
non-public contracts increased by $2.2 million for the year ended December 31,
1997, primarily the result of contracts with new school districts. Revenue
from PACE contracts accounted for $6.2 million of the increase for 1997. The
PACE increase resulted primarily from contracts with new customers.

Revenue from new public and non-public contracts obtained after December 31,
1996 contributed $5.3 million to revenue for 1997. Revenue from existing
public and non-public contracts obtained before December 31, 1996 decreased by
$3.1 million in 1997, primarily related to reduced funding in certain school
districts and certain contracts expiring in 1997.

Testing services revenue increased by $48.3 million, or 56%, to $135.3
million during the year ended December 31, 1997, compared to the year ended
December 31, 1996. The increase in testing services revenues resulted mainly
from increased services under Educational Testing Service (ETS) contracts,
which included the cost-plus international contract, GRE, GMAT, and TOEFL, and
certain volume-based pricing adjustments, testing in the information technology
and professional licensure businesses. WSI, acquired in December 1996,
contributed $19.0 million of the revenue increase.

Cost and Expenses. Total direct costs increased 37%, from $150.4 million in
1996 to $206.6 million in 1997 and increased as a percentage of total revenues
from 83% in 1996 to 84% in 1997 as a result of non-recurring expenses of $21.5
million being included in direct costs in 1997, as discussed below. Excluding
the non-recurring expenses, total direct costs as a percentage of total
revenues would be 75% for the year ended December 31, 1997.

Core educational services expense increased 44% from $25.6 million in 1996 to
$36.7 million in 1997. Included in core educational services expense for the
1997 period is advertising expense related to a non-recurring $5.0 million
contribution of the Company's common stock to a non-profit corporation whose
sole purpose is to develop and fund advertising programs for the Sylvan
Learning Centers. Franchise services expense increased by $8.0 million, to
$17.5 million or 82% of franchise related revenues for the year ended December
31, 1997, compared to $9.5 million, or 52% of franchise related revenues for
the year ended December 31, 1996. The lower margin in franchise services was
primarily due to the non-recurring expense discussed above, as well as to costs
incurred for development of new financing and after-school programs and
additional management staff for the Learning Center division.

Company-owned Learning Center expense increased by $3.1 million, to $19.2
million or 85% of Company-owned Learning Center services revenues for the year
ended December 31, 1997, compared to $16.1 million, or 87% of Company-owned
Learning Center services revenues for the year ended December 31, 1996. The
increase resulted from $1.1 million of expenses associated with 13 acquired
Learning Centers, and increases in advertising, labor and general overhead
associated with increased Center enrollment. Expenses for Centers operating
over 12 months as of December 31, 1997 accounted for $2.0 million of the
increase for 1997.

17


Contract educational services expense increased by $2.7 million to $56.1
million, or 84% of contract educational services revenues during 1997, compared
to $53.4 million, or 92% of contract educational services revenues during 1996.
Operating expenses for public and non-public schools decreased $1.3 million,
while operating expenses for PACE increased by $3.5 million for the year ended
December 31, 1997. The decrease in contract educational services expense as a
percentage of revenue for 1997 versus 1996 is the result of increased profit
margins for PACE and public and non-public services in 1997, as well a higher
mix of revenue from PACE contracts which generate a higher profit margin than
public and non-public services. In March 1998, the additional contingent
consideration payable to the former shareholders of PACE resulting from the
purchase of PACE in 1995 was determined to be $25.8 million, which was
recorded as additional goodwill and is being amortized over the estimated
remaining useful life of 22 years. This amount will increase the amount of
amortization associated with the contract educational services segment by
$1.2 million in 1998.

Testing service expenses for the year ended December 31, 1997 increased by
$42.4 million to $113.9 million, or 84% of total testing services revenue,
compared to $71.5 million, or 82% of total testing services revenue for the
year ended December 31, 1996. The increase in testing services expense as a
percentage of testing services revenues was predominantly a result of a non-
recurring marketing expense of $10.0 million related to a contribution to IT
Training Marketing Company, a nonprofit corporation whose sole purpose is to
fund promotional and channel support programs for the Sylvan Prometric
distribution channel. The 1996 expense includes $2.4 million of non-recurring
charges related to the Drake acquisition, incurred during the first and second
quarter of 1996. Excluding these effects, expenses as a percentage of total
testing revenue for 1997 and 1996 were 77% and 79%, respectively. This
decrease in recurring expenses as a percentage of testing services revenue was
primarily due to the fixed expenses of the division being spread over a higher
revenue base as well as the effects of a full year of results of WSI, at higher
incremental margins, being included in 1997 compared to only one month in the
1996 period.

General and administrative expenses increased by $11.7 million to $20.5
million during 1997 and increased as a percentage of revenues from 4.8% to
8.3%. Included in general and administrative expenses is a non-recurring
expense related to a contribution of the Company's common stock valued at $6.5
million to Sylvan Learning Foundation, Inc., a nonprofit foundation formed to
promote various educational pursuits. Excluding this non-recurring expense,
general and administrative expenses are 5.7% of total revenues for 1997. The
expenses did not decrease as a percentage of revenues as a result of increased
administrative staff, leased space costs and other expenses which were added to
support the current and expected growth in the Company's three divisions.

In March 1997, the Company and National Education Corporation ("NEC")
executed a definitive agreement pursuant to which the Company was to acquire
NEC. In May 1997, NEC accepted a competing offer which resulted in the
termination of NEC's agreement with the Company. As a result, NEC paid the
Company a $30.0 million termination fee, which has been recorded, net of $1.5
million of transaction costs, as a separate component of non-operating income.

In May 1997, the Company determined that certain assets of Sylvan Prometric
were impaired as a result of certain strategic changes that were made as a
result of pursuing the NEC acquisition. During and after the acquisition
negotiations with NEC, the Company developed certain plans that resulted in
required changes in both software systems and hardware currently utilized in
Sylvan Prometric's network of centers. The plans continued to be valid for the
Company even after the NEC acquisition was terminated. The impaired assets,
consisting of computer equipment and software, were impaired as a result of
changes in the technical requirements and specifications of certain computer
hardware and software. The amount of the impairment loss was determined by
evaluating the likely sales proceeds from the disposition of the assets
compared to their book value. The Company determined that it was unlikely that
the net cash proceeds from the sale of any assets would be significant, and
therefore recorded an impairment loss equal to the net book value of the assets
of $4.0 million.

Investment and other income increased by $2.9 million to $4.5 million during
1997, primarily due to the $2.0 million non-cash dividend income received from
the Company's investment in JLC Holdings, Inc. and the higher

18


cash and investment balances resulting from the NEC termination fee and the
proceeds received from the sale of the Company's common stock during 1997. The
Company's interest expense decreased by $0.5 million due to the repayment of all
outstanding Educational Inroads debt in the second quarter of 1997.

The Company reported losses of $2.1 million in 1997 from its investment in
affiliates, consisting primarily of $1.4 million attributable to Caliber
Learning Network, Inc., in which the Company has an equity investment. The
Company and MCI Communications Corp. organized Caliber in November of 1996.

The Company's effective tax rate has decreased from 37% during the 1996 to
35% during 1997 mainly due to the effect of proportionately higher earnings
levels attributable to foreign countries with lower tax rates than the U.S.

19


Comparison of results for the year ended December 31, 1996 to the year ended
December 31, 1995.

Revenues. Total revenues increased 64%, from $111.1 million in 1995 to $181.9
million in 1996. This increase resulted from greater revenues in all business
segments--core educational services, testing services and contract educational
services.

Core educational services revenues increased 41%, from $26.1 million in 1995
to $36.8 million in 1996. Franchise royalties increased 21%, from $9.2 million
in 1995 to $11.2 million in 1996. This increase in franchise royalties was due
to an overall 19% increase in revenues at Learning Centers that had been
operating for more than one year as of December 31, 1996 combined with a net
increase of 49 Learning Centers opened during 1996.

Franchise sales fees increased 49%, from $2.1 million in 1995 to $3.2 million
in 1996. During 1996, there were four area development agreements sold for $1.7
million and 38 franchise Learning Center licenses sold, compared to two area
development agreements sold for $550,000 and 43 Learning Center licenses sold
during 1995.

Revenues from Company-owned Learning Centers increased 61%, from $11.5
million in 1995 to $18.5 million in 1996. Revenue growth related to increased
student enrollment at Learning Centers that had been operating for more than
one year as of December 31, 1996, resulted in $3.4 million, or 30%, of the
increase from 1995 to 1996. Approximately $3.2 million of the revenue increase
resulted from the acquisition of 11 Learning Centers from two franchisees. The
opening of one new Learning Center during 1996 resulted in an additional
$350,000 of revenues during 1996. Product sales increased 23%, from $3.2
million in 1995 to $3.9 million in 1996. This increase resulted from overall
student enrollment increases at franchised Learning Centers.

Contract educational services revenues increased 15%, from $50.4 million in
1995 to $58.2 million in 1996. Revenues from public and non-public school
contracts accounted for $5.9 million of the increase, and greater revenues from
PACE accounted for $1.9 million of the increase. The PACE increase primarily
resulted from the fact that the acquisition, accounted for as a purchase, was
effective February 28, 1995, and as such the 1995 revenues of Sylvan only
reflect ten months of PACE revenues.

Revenues from public and non-public school contracts executed during 1996
contributed $2.2 million to 1996 revenues. Revenues from public and non-public
school contracts executed during 1995 increased by $4.6 million in 1996,
primarily because a full year of revenues were generated under these contracts
during 1996.

Testing services revenues increased 152%, from $34.6 million in 1995 to $87.0
million in 1996. The significant increase in testing services revenues resulted
primarily from the September 1995 acquisition of Drake, which provided
increased revenues from IT clients. Increased services under ETS contracts,
including the cost-plus international contract and the Graduate Record Exam
(the "GRE"), and other professional testing revenue increases, including NASD
testing, which began in February 1996, also contributed to the increase in
testing services revenues.

Cost and Expenses. Total direct costs increased 56%, from $96.7 million in
1995 to $150.4 million in 1996, but decreased as a percentage of total revenues
from 87% in 1995 to 83% in 1996. Core educational services expense increased
37%, from $18.7 million in 1995 to $25.6 million in 1996. Franchise services
expense increased 11%, from $5.9 million in 1995 to $6.5 million in 1996 but
decreased as a percentage of franchise royalties and sales revenues from 52% in
1995 to 46% in 1996. The increased margin in 1996 primarily related to the
effects of leveraging the fixed costs of supporting this line of business over
a larger revenue base. Company-owned Learning Center expense increased 55%,
from $10.4 million in 1995 to $16.1 million in 1996 but decreased as a
percentage of Company-owned Learning Center services revenues from 90% in 1995
to 87% in 1996. Of the increase, $3.1 million related to the acquisition of 11
Learning Centers. The remaining increase is primarily from advertising, labor
and general overhead expense associated with increased enrollment at Learning
Centers that had been operating prior to 1996.

20


Contract educational services expense increased 12%, from $47.7 million in
1995 to $53.4 million in 1996 but decreased as a percentage of contract
educational services revenues from 95% in 1995 to 92% in 1996. The decline in
these expenses as a percentage of contract educational services revenues
resulted from increased revenues without corresponding increases in overhead.
Operating expenses for public and non-public school contracts increased $4.6
million during 1996, while operating expenses for PACE increased $1.1 million
during the same period. The PACE increase resulted from the fact that the
acquisition, accounted for as a purchase, was effective February 28, 1995, and
as such the 1995 results only reflect ten months of PACE results.

Testing services expense increased 136%, from $30.3 million in 1995 to $71.5
million in 1996 but decreased as a percentage of testing services revenue from
88% in 1995 to 82% in 1996. The increased expense resulted primarily from the
acquisition of Drake and the increased registration and delivery costs
associated with an increased volume of tests. Testing services expense in 1996
included $2.4 million of amortization of contract rights related to the Drake
acquisition. Testing services expense in 1995 included $4.1 million of
amortization of contract rights, imputed interest and salary termination
charges related to the Drake acquisition. Excluding non-recurring charges,
testing services expense, as a percentage of testing services revenues,
increased from 76% in 1995 to 79% in 1996. The principal reasons for this
percentage increase in 1996 are the full year amortization of goodwill
associated with the Drake acquisition and increased staffing levels required to
meet the growth in business volumes that occurred during 1996 and expected
growth in business activity in 1997.

General and administrative expense increased 41%, from $6.2 million in 1995
to $8.8 million in 1996, but decreased as a percentage of total revenues, from
6% in 1995 to 5% in 1996. The percentage decline resulted from increased
revenues in all segments without corresponding increases in overhead.

There was $1.4 million of net interest expense in 1995 and $0.6 million of
net interest income in 1996. This change resulted primarily from the $1.1
million of interest expense imputed on the purchase of Drake and an increase in
the average invested cash amounts in 1996 compared to 1995.

The Company's effective tax rate increased from 6% in 1995 to 37% in 1996.
This increase was the primarily the result of a 1995 decrease in the amount of
the valuation allowance for deferred tax assets, consisting principally of net
operating loss carryforwards.

LIQUIDITY AND CAPITAL RESOURCES

Cash provided by operating activities increased $31.9 million, from $23.6
million in 1996 to $55.5 million in 1997. This increase is attributable to a
variety of factors, the most significant of which was a $35.5 million increase
in operating income before non-cash charges.

Sylvan's investment in working capital continues to reduce net cash flow from
operations, particularly as a result of the growth in accounts and notes
receivable. The $26.4 million increase in accounts and notes receivable is
principally the result of a 35% increase in revenue during 1997. Of the $26.4
million cash flow reduction attributable to an increase in accounts and notes
receivable, $12.3 million is related to Sylvan's expanding testing contracts
and $3.8 million is related to new and expanded public school contracts. The
increase in amounts due from expanding testing contracts resulted from higher
domestic testing volumes and a significant increase in billings under the
international contract with ETS to establish overseas testing capacity. ETS
typically makes monthly payments for domestic activity and quarterly payments
for international services. Accounts receivable from public school-based
programs have increased due to billings under new contracts obtained in 1996
and 1997. Notes receivable for new area development agreements accounted for
$3.2 million of the increase in 1997 and a note receivable from one of the
former owners of WSI accounted for another $2.0 million. Increases in revenue
for all business segments contributed to the remaining accounts and note
receivable increase of $5.1 million. Sylvan believes that uncollectible
accounts receivable will not have a significant effect on future liquidity, as
a significant portion of its accounts receivable are due from enterprises with
substantial financial resources, such as ETS and governmental units.

21


Cash flow from operations in 1997 was favorably impacted by an increase in
accounts payable, accrued expenses and income taxes payable of $16.3 million.
This increase relates to the overall increase in expenses, including income
taxes, of $79.4 million.

The Company's investing activities include the investment of excess cash in
available-for-sale securities. During 1997, the Company's investments
increased $66.5 million to $82.9 million. These investments are readily
marketable and available for use in current operations. The Company also made
$9.3 million of additional investments or loans to affiliates accounted for
using the equity method, consisting primarily of additional investments and
loans to Caliber Learning Network, Inc., in the amount of $7.2 million. In
January 1997, the Company completed the acquisition of WSI and paid cash to the
sellers and incurred acquisition costs totaling $4.7 million.

Sylvan continues to incur expenditures for additions to property and
equipment, which totaled $28.7 million in 1997. These additions consist
primarily of furniture and equipment for general business expansion, including
expenditures for the headquarters facility, new public school-based programs'
classrooms, and equipment needed for overseas testing centers operated by
Sylvan. Under the international testing contract with ETS, Sylvan is reimbursed
for overseas equipment expenditures as the equipment is depreciated. This
reimbursement includes a financing charge over the reimbursement period.

The Company has entered into a loan agreement with a bank, (hereinafter the
"credit line") that provides an unsecured revolving line of credit. The credit
line allows the Company to borrow a maximum of $15.0 million through the
expiration date of May 31, 1998, at which time the total outstanding principal
balance can be converted into a term loan, at the option of the Company. The
term loan would be repaid over 24 months from the date of issuance. The credit
line and the term loan both bear interest at a floating rate equal to the 30
day London Interbank Offered Rate ("LIBOR") plus 1.15% per annum. The credit
line had no outstanding borrowings at December 31, 1997.

In the third quarter of 1997, the Company issued 2,062,292 shares of its
common stock for net proceeds of $73.7 million, after underwriting costs and
expenses. The Company also received $5.0 million of cash as a result of the
exercise of stock options and warrants to purchase 1,137,245 shares of common
stock in 1997.

The Company will be required to make cash payments of $13.5 million in 1998
to the former shareholders of PACE in settlement of contingent consideration
arising from the 1995 acquisition of PACE. This amount has been classified as a
current liability in the consolidated balance sheet at December 31, 1997. Also,
as of December 31, 1997, the Company is obligated to issue directly to certain
shareholders of acquired companies common stock with a value of $56.4 million.
This amount is classified as a long-term liability in the consolidated balance
sheet at December 31, 1997. The Company has nominal amounts of long-term debt
outstanding at December 31, 1997.

Sylvan believes that its capital resources will be sufficient over the next
12 to 24 months to fund expected expansion of its business, including working
capital needs and expected investments in property and equipment.

Sylvan continues to review other companies in the education or computer-based
testing industries for potential acquisitions. Additional capital resources
may be necessary to acquire and thereafter operate additional businesses.


CONTINGENT MATTERS

In connection with the PACE acquisition, Sylvan will be required to make a
contingent payment equal to 6.5 times PACE's 1997 earnings before interest and
income taxes ("EBIT"). EBIT in 1997 was $4.0 million, resulting in additional
consideration of $25.8 million. The contingent payment is payable $13.5 million
in cash ($14.5 million offset by $1.0 million of amounts owed the Company by the
former owners of PACE) and the remainder in shares of common stock. The Company
has recorded this additional consideration as a liability and increased
goodwill and will amortize that amount over the remaining estimated recovery
period.

22


Upon the acquisition of Drake in September 1995, the Company entered into two
contingent payment obligations related to the acquisition. The first related
to 1,785,714 shares of common stock (the "Revenue Escrow Shares") that were
placed in escrow to be released to the sellers provided certain revenue targets
relating to portions of the computer-based testing business are achieved from
1996 through 1998. Based on testing revenues earned by the Company in 1996 and
1997, 60% of the Revenue Escrow Shares (1,071,429 shares) have been earned
through December 31, 1997. As of December 31, 1997, an additional $28.2
million of goodwill related to the earned shares was recorded and will be
amortized over the remaining estimated useful life. The 714,286 Revenue Escrow
Shares earned in 1997 will be released to the sellers in 1998.

The sellers of Drake may receive up to an additional $40.0 million (payable
12.5% in cash and the balance in either cash or restricted shares of common
stock, at the Company's option) as a second component of contingent
consideration. This component will be earned if other revenue targets relating
to portions of the combined computer-based testing business are achieved in
1998 or 1999 (with the measuring year selected by the sellers).

Sylvan has put in place a corporate-wide Year 2000 task force with
representatives for each business segment. This task force has conducted a
comprehensive review of Sylvan's computer systems to identify the systems that
would be affected by the Year 2000 issue and is developing an implementation
plan to resolve the issues. The Company is also surveying critical suppliers
and customers to determine the status of their Year 2000 compliance programs.
The Company presently believes that, with modifications to the existing systems
and implementation of new hardware and software, the Year 2000 project will not
pose any significant operational problems. The Company anticipates completing
the Year 2000 project by June of 1999. The future and total costs relating to
the Year 2000 issue are not expected to have a material impact on the Company's
consolidated financial position, results of operations or cash flow.

EFFECTS OF INFLATION

Inflation has not had a material effect on Sylvan's revenues and income from
continuing operations in the past three years. Inflation is not expected to
have a material future effect.

QUARTERLY FLUCTUATIONS

Sylvan's revenues and operating results have varied substantially from
quarter to quarter and may continue to vary, depending upon the timing of
implementation of new computer-based testing contracts and contracts funded
under Title I or similar programs. Based on Sylvan's limited experience,
revenues generated by computer-based testing services may vary based on the
frequency or timing of delivery of individual tests and the speed of test
administrators' conversion of tests to computer-based format. In addition,
franchise license fees earned by the Company in its core educational services
and testing services segments may vary significantly from quarter to quarter.
Revenues or profits in any period will not necessarily be indicative of results
in subsequent periods.



ITEM 8. FINANCIAL STATEMENTS

The financial statements of the Company are included on pages 29 through 63
of the report as indicated on page 28.


ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

There were no changes in accountants, disagreements, or other events
requiring reporting under this Item.

23


PART III.
---------

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF SYLVAN LEARNING SYSTEMS, INC.

Information required is set forth under the caption "Election of Directors"
in the Proxy Statement relating to the 1998 Annual Meeting of Shareholders,
which is incorporated by reference.

Information required pertaining to compliance with Section 16 (a) of the
Securities and Exchange Act of 1934 is set forth under the caption "Election of
Directors" in the Proxy Statement relating to the 1998 Annual Meeting of
Shareholders, which is incorporated by reference.


ITEM 11. EXECUTIVE COMPENSATION

Information required is set forth under the caption "Executive Compensation"
in the Proxy Statement relating to the 1998 Annual Meeting of Shareholders,
which is incorporated by reference.


ITEM 12. SECURITY OWNERSHIP AND CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information required is set forth under the caption "Security Ownership" in
the Proxy Statement relating to the 1998 Annual Meeting of Shareholders, which
is incorporated by reference.


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information required is set forth under the caption "Certain Transactions" in
the Proxy Statement relating to the 1998 Annual Meeting of Shareholders, which
is incorporated by reference.

PART IV.
--------

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) The following documents are filed as a part of this report:

1. FINANCIAL STATEMENTS

The response to this portion of Item 14 is submitted as a separate section
of this Report.

2. FINANCIAL STATEMENT SCHEDULES

All schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are inapplicable or
immaterial and therefore have been omitted.

(b) Reports on Form 8-K:

The Registrant did not file any reports on Forms 8-K and 8-K/A during the
fourth quarter ended December 31, 1997.

3. EXHIBITS

24


(a) Exhibits:



Exhibit
Number Description
- ------------ -----------

3.01 Articles of Amendment and Restatement of the Charter.(b)
3.03 Amended and Restated Bylaws dated September 27, 1996.(n)
4.01 Specimen Common Stock Certificate.(b)
4.02 Form of Warrant to Purchase Common Stock of Sylvan KEE Systems, Inc. dated January 26, 1993.(b)
4.03 Form of Warrant to Purchase Common Stock of Sylvan KEE Systems, Inc. dated July 14, 1993.(b)
4.07 Rights Agreement by and between Registrant and State Street Bank & Trust Company dated as of October 1,
1996.(i)
5.01 Opinion of Piper & Marbury L.L.P.(a)
10.01 Agreement of Lease by and between Rouse & Associates-Quarry and KEE Systems, Inc. dated May 15, 1990.(b)
10.02 Agreement of Lease by and between Rouse & Associated-Quarry and KEE Systems, Inc. dated May 6, 1990.(b)
10.03 Lease Agreement between Harbor East Parcel G-Office, LLC and Sylvan Learning Systems, Inc. dated August
24, 1995(c)
10.04 Master Agreement Between Educational Testing Service and Sylvan Learning Systems, Inc. for
Computer-Based Testing Services at Sylvan Technology Centers dated September 1, 1993. (Portions of this
document have been omitted pursuant to a request for confidential treatment.)(b)
10.05 Term Lease Master Agreement between Sylvan Learning Systems and IBM Credit Corporation dated March 31,
1992.(b)
10.06 Director Stock Option Plan.(b)
10.07 Employee Stock Option Plan.(b)
10.08 Management Stock Option Plan.(b)
10.19 KEE, Incorporated Non-Qualified Stock Option Plan.(b)
10.10 Sylvan Employee Confidentiality and Non-Disclosure Agreement and Covenant Not to Compete.(b)
10.11 $2.5 Million Revolving Loan, $3.76 Million Term Loan and $5.0 Million Revolving Loan with NationsBank.(d)
10.12 Indemnification Agreement by and between Sylvan KEE Systems, Tom D. Wippman and David H. Jacobson dated
September 17, 1992.(b)
10.13 Guaranty Agreement by Sylvan KEE Systems in favor of Encyclopedia Britannica, Inc. dated October 1,
1992.(b)
10.14 Form of Non-Competition Agreement by and between Sylvan KEE Systems, Inc. and Douglas L. Becker dated
January 26, 1993.(b)
10.15 Certification and Testing Services Agreement by and between TRO Learning, Inc. and
Sylvan Learning Systems, Inc. dated August 31, 1993.(b)
10.16 Plato Educational Products Purchase and License Agreement by and between TRO Learning, Inc. and Sylvan
Learning Systems, Inc. dated August 31, 1993.(b)
10.17 Form of Franchise Agreement.(b)
10.18 Form of Technology Center Agreement.(b)
10.19 Agreement and Plan of Reorganization dated July 14, 1994 by and between Registrant and Learning
Services, Inc.(e)
10.20 Agreement and Plan of Reorganization dated July 14, 1994 by and between Registrant and Loralex Learning,
Inc.(e)
10.21 Agreement and Plan of Reorganization dated February 17, 1995 by and between Registrant and Remedial
Education and Diagnostic Services, Inc.(f)
10.22 Agreement and Plan of Reorganization dated as of March 1, 1995, by and between Registrant and the PACE
Group.(g)
10.23 Agreement and Plan of Reorganization dated as of July 28, 1995, by and between Registrant and Drake
Prometric, L.P.(h)


25





10.24 Lease Agreement dated August 24, 1995, First Amendment dated May 13, 1996 and Second Amendment dated
November 11, 1996 by and between Registrant and Harbor East, LLC.(n)
10.25 Revolving Credit Note to NationsBank, N.A. dated December 31, 1996.(n)
10.26 Senior Management Option Plan dated March 29, 1996.(n)
10.27 Securities Purchase Agreement by and between Registrant and JLC Holdings, Inc., Software Systems
Corporation and JLC Learning Corporation dated November 1, 1996.(j)
10.28 Agreement and Plan of Reorganization dated January 28, 1997 by and between Registrant and Wall Street
Institute.(k)
10.29 Agreement and Plan of Reorganization dated May 30, 1997 among Registrant and I-R, Inc. and Independent
Child Study Teams, Inc.(l)
10.30 Sylvan Learning Systems, Inc. Employee Stock Purchase Plan.(m)
21.00 Subsidiaries of the Registrant.(n)
23.01 Consent of Ernst & Young LLP.
23.02 Consent of Deloitte & Touche L.L.P.
27.01 Financial Data Schedule for the year ended December 31, 1997.
27.02 Financial Data Schedule for the years ended December 31, 1995 and 1996.
27.03 Financial Data Schedule for the three months ended March 31, 1997 and 1996.
27.04 Financial Data Schedule for the three months ended June 30, 1997 and 1996.
27.05 Financial Data Schedule for the six months ended June 30, 1997 and 1996.
27.06 Financial Data Schedule for the three months ended September 30, 1997 and 1996.
27.07 Financial Data Schedule for the nine months ended September 30, 1997 and 1996.
99.01 Opinion of Deloitte & Touche L.L.P.
99.02 Opinion of Deloitte & Touche L.L.P.


(a) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-1 dated February 26, 1996.
(b) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-1 (Registration No. 33-69558).
(c) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-3 as amended by a Registration Statement on Form S-1
(No. 33-97870).
(d) Incorporated by reference from the Exhibits to the Company's Quarterly
Report for the Quarter ended September 30, 1995.
(e) Incorporated by reference to the Company's Current Report on Form 8-K dated
July 20, 1994.
(f) Incorporated by reference to the Company's Current Report on Form 8-K dated
February 27, 1995.
(g) Incorporated by reference to the Company's Current Report on Form 8-K dated
May 5, 1995.
(h) Incorporated by reference to the Company's Current Report on Form 8-K dated
July 21, 1995.
(i) Incorporated by reference to the Company's Current Report on Form 8-K dated
September 27, 1996.
(j) Incorporated by reference to the Company's Current Report on Form 8-K dated
November 1, 1996.
(k) Incorporated by reference to the Company's Current Report on Form 8-K dated
January 28, 1997.
(l) Incorporated by reference to the Company's Current Report on Forms 8-K and
Form 8-K/A dated April 17, 1997 and May 30, 1997.
(m) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-8 dated February 18, 1997.
(n) Incorporated by reference from the Exhibits to the Company's Form 10-K
filed March 31, 1997.

26


SIGNATURES
----------

Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
of the undersigned, thereunto duly authorized on March 31, 1998.

SYLVAN LEARNING SYSTEMS, INC.
(Registrant)



By: /s/ R. Christopher Hoehn-Saric
------------------------------------
R. Christopher Hoehn-Saric
Chairman of the Board


Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on March 31, 1998


SIGNATURE CAPACITY
- --------- --------


/s/ R. Christopher Hoehn-Saric Director and Chairman of the Board
- ------------------------------------------
R. Christopher Hoehn-Saric


/s/ Douglas L. Becker Secretary
- ------------------------------------------
Douglas L. Becker


/s/ B. Lee McGee Vice President and Chief
- ------------------------------------------ Financial Officer
B. Lee McGee


/s/ Donald Berlanti Director
- ------------------------------------------
Donald Berlanti


/s/ Phillip Samper Director
- ------------------------------------------
Phillip Samper


/s/ James H. McGuire Director
- ------------------------------------------
James H. McGuire


/s/ Rick Inatome Director
- ------------------------------------------
Rick Inatome


/s/ R. William Pollock Director
- ------------------------------------------
R. William Pollock


/s/ Nancy S. Cole Director
- ------------------------------------------
Nancy S. Cole

27


ITEM 14 (A) (1)

INDEX TO FINANCIAL STATEMENTS



PAGE
----
THE COMPANY:

Report of Independent Auditors............................................................... 29
Consolidated Balance Sheets as of December 31, 1996 and December 31, 1997.................... 30
Consolidated Statements of Income for the years ended December 31, 1995, 1996 and 1997....... 32
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1996
and 1997................................................................................... 33
Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997... 34
Notes to Consolidated Financial Statements................................................... 35


28


Report of Independent Auditors

The Board of Directors and Stockholders
Sylvan Learning Systems, Inc.

We have audited the consolidated balance sheets of Sylvan Learning Systems, Inc.
as of December 31, 1997 and 1996, and the related consolidated statements of
income, stockholders' equity, and cash flows for each of the three years in the
period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits. We did not audit the
financial statements of I-R, Inc. and Independent Child Study Teams, Inc., which
statements reflect combined total assets constituting 3% of 1996 consolidated
total assets, and which reflect combined revenues constituting 14% and 21% of
consolidated total revenues for the years ended December 31, 1996 and 1995.
Those statements were audited by other auditors whose reports have been
furnished to us, and our opinion, insofar as it relates to data included for
I-R, Inc. and Independent Child Study Teams, Inc., is based solely on the
reports of the other auditors.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the reports of other auditors provide a
reasonable basis for our opinion.

In our opinion, based on our audits and the reports of other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of Sylvan Learning Systems, Inc. at December
31, 1997 and 1996, and the consolidated results of its operations and its cash
flows for each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.

/s/ Ernst & Young LLP

Baltimore, Maryland
February 25, 1998




29


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS


December 31, December 31,
1996 1997
--------------- ---------------

ASSETS
Current assets:
Cash and cash equivalents $ 11,198,106 $ 23,150,106
Available-for-sale securities 16,448,759 82,925,569

Receivables:
Accounts receivable 36,431,363 56,187,522
Costs and estimated earnings in excess of billings
on uncompleted contracts 3,565,201 3,899,760
Notes receivable 3,007,473 2,942,861
Other receivables - 7,000,000
--------------- ---------------
43,004,037 70,030,143
Allowance for doubtful accounts (1,378,854) (1,754,682)
--------------- ---------------
41,625,183 68,275,461

Inventory 4,469,577 4,777,542
Deferred income taxes 619,553 3,737,831
Prepaid expenses and other current assets 3,124,802 3,674,563
--------------- ---------------
Total current assets 77,485,980 186,541,072

Notes receivable, less current portion 562,989 6,231,651
Costs and estimated earnings in excess of billings
on uncompleted contracts, less current portion 549,448 351,712

Property and equipment:
Furniture and equipment 37,952,268 55,381,518
Leasehold improvements 5,543,726 7,649,845
--------------- ---------------
43,495,994 63,031,363
Accumulated depreciation (15,577,693) (18,725,260)
--------------- ---------------
27,918,301 44,306,103

Intangible assets:
Goodwill 103,986,427 182,167,949
Contract rights 13,881,337 13,972,800
Other 2,570,091 2,522,391
--------------- ---------------
120,437,855 198,663,140
Accumulated amortization (10,736,219) (16,649,374)
--------------- ---------------
109,701,636 182,013,766

Deferred contract costs, net of accumulated amortization
of $2,066,893 as of December 31, 1996 and $6,205,393
as of December 31, 1997 13,230,340 10,323,898

Investments in and advances to affiliates 5,895,602 12,463,729
Other investments 22,219,888 28,017,457
Other assets 2,025,337 3,266,176
--------------- ---------------
Total assets $ 259,589,521 $ 473,515,564
=============== ===============


30


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS


December 31, December 31,
1996 1997
------------------- -------------------

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 28,575,931 $ 36,435,373
Income taxes payable - 4,876,458
Current portion of long-term debt 3,182,197 930,231
Current portion of due to shareholders of
acquired companies 4,920,565 13,794,195
Deferred revenue 9,542,578 11,751,722
Other current liabilities 1,661,776 779,415
------------------- -------------------
Total current liabilities 47,883,047 68,567,394

Long-term debt, less current portion 2,170,101 -
Deferred income taxes 2,338,154 7,334,903
Due to shareholders of acquired companies,
less current portion 26,525,855 56,365,578
Other long-term liabilities 349,771 876,809

Commitments and contingent liabilities - -

Stockholders' equity:
Preferred stock, par value $.01 per share--authorized
10,000,000 shares, no shares issued and
outstanding as of December 31, 1997 and 1996 - -
Common stock, par value $.01 per share--authorized
40,000,000 shares, issued and outstanding shares of
23,980,215 as of December 31, 1996 and 28,964,278
as of December 31, 1997 239,802 289,643
Additional paid-in capital 168,547,097 301,390,840
Retained earnings 11,550,868 39,652,003
Unrealized losses on available for sale securities (11,043) -
Foreign currency translation adjustments (4,131) (961,606)
------------------- -------------------
Total stockholders' equity 180,322,593 340,370,880
------------------- -------------------


Total liabilities and stockholders' equity $ 259,589,521 $ 473,515,564
=================== ===================

See accompanying notes.

31


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME



Years Ended December 31,
----------------------------------------------------------
1995 1996 1997
----------------------------------------------------------

REVENUES $ 111,058,550 $ 181,935,961 $ 246,211,733
COST AND EXPENSES
Direct costs 96,708,097 150,448,547 206,620,955
General and administrative expense 6,205,480 8,755,406 20,467,883
Loss on impairment of assets 3,315,541 - 4,000,000
------------------ ---------------- ----------------
Total expenses 106,229,118 159,203,953 231,088,838
------------------ ---------------- ----------------

Operating income 4,829,432 22,732,008 15,122,895

OTHER INCOME (EXPENSE)
Termination fee, net of direct costs - - 28,500,000
Investment and other income 957,169 1,622,240 4,532,203
Interest expense (2,396,803 (1,071,323) (525,859)
Equity in net income (loss) of affiliates 390,692 363,396 (2,131,240)
------------------ --------------- --------------
Income before income taxes 3,780,490 23,646,321 45,497,999

Income taxes (209,159 (8,850,000) (16,064,000)
------------------ --------------- ---------------
Net income $ 3,571,331 $ 14,796,321 $ 29,433,999
================== ================ ===============


Earnings per common share, basic $ 0.24 $ 0.64 $ $1.09
================== =============== ===============


Earnings per common share, diluted $ 0.2 $ 0.60 $ $1.03
==================== ================ ==============


See accompanying notes.

32


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity



RETAINED
ADDITIONAL EARNINGS
COMMON PAID-IN (ACCUMULATED
STOCK CAPITAL DEFICIT)
---------- -------------- ---------------

Balance at January 1, 1995 $ 145,713 $ 38,851,651 $ (6,496,973)

Options and warrants exercised for purchase
of 731,871 shares of common stock 7,319 4,210,937
Issuance of 262,446 shares of common stock in
connection with the acquisition of PACE 2,624 3,158,237
Issuance of 3,928,572 shares of common stock
in connection with the acquisition of Drake 39,286 49,460,714
Issuance of 2,850,000 shares of common
stock, net of offering costs of $3,367,266 28,500 44,104,234
Foreign currency translation adjustment
Unrealized gain (loss) on available-for-sale securities
Net income for 1995 3,571,331
---------- -------------- ---------------

Balance at December 31, 1995 223,442 139,785,773 (2,925,642)

Options and warrants exercised for purchase of 661,700
shares of common stock, including income tax
benefit of $1,887,006 6,617 6,991,426
Issuance of 824,000 shares of common stock in connection
with the investment in Jostens Learning Corporation 8,240 21,209,760
Issuance of 116,605 shares of common stock in
connection with other acquisitions 1,166 27,225 (319,811)
Exercise of underwriter's overallotment option to purchase
33,750 shares of common stock in connection with 1995
public stock offering 337 532,913
Foreign currency translation adjustment
Unrealized gain (loss) on available-for-sale securities
Net income for 1996 14,796,321
---------- -------------- ---------------

Balance at December 31, 1996 239,802 168,547,097 11,550,868

Options and warrants exercised for purchase of 1,137,245
shares of common stock, including income tax
benefit of $8,155,946 11,356 13,108,119
Issuance of 357,143 shares of common stock in connection with
contingent consideration related to the acquisition of Drake 3,571 8,139,285
Issuance of 714,884 shares of common stock in connection
with the acquisition of WSI 7,149 15,312,982
Issuance of 269,118 shares of common stock to Sylvan
Learning Foundation as charitable contribution 2,691 6,538,309
Issuance of 205,882 shares of common stock to IT Training
Marketing Company as marketing expense 2,059 6,997,941
Issuance of 176,470 shares of common stock to SLC National
Advertising Fund, Inc. as advertising expense 1,765 4,998,235
Issuance of 2,062,292 shares of common stock for cash
- net of offering costs of $3,645,455 20,623 73,669,872
Capital contribution by former shareholders of Educational Inroads 2,810,930
Distributions to former shareholders of Educational Inroads (1,332,864)
Issuance of 62,562 shares of common stock in connection
with other acquisitions 627 718,070
Stock options to purchase 211,000 shares of common stock
granted to non-employees 550,000
Foreign currency translation adjustment
Unrealized gain (loss) on available-for-sale securities
Net income for 1997 29,433,999
---------- -------------- ---------------

Balance at December 31, 1997 $ 289,643 $ 301,390,840 $ 39,652,003
---------- -------------- ---------------





UNREALIZED FOREIGN
HOLDING CURRENCY TOTAL
GAINS / TRANSLATION STOCKHOLDERS'
(LOSSES) ADJUSTMENTS EQUITY
------------- -------------- ----------------

Balance at January 1, 1995 $ (19,846) $ - $ 32,480,545
Options and warrants exercised for purchase
of 731,871 shares of common stock 4,218,256
Issuance of 262,446 shares of common stock in
connection with the acquisition of PACE 3,160,861
Issuance of 3,928,572 shares of common stock
in connection with the acquisition of Drake 49,500,000
Issuance of 2,850,000 shares of common
stock, net of offering costs of $3,367,266 44,132,734
Foreign currency translation adjustment 70,000 70,000
Unrealized gain (loss) on available-for-sale securities 14,409 14,409
Net income for 1995 3,571,331
------------- -------------- ----------------


Balance at December 31, 1995 (5,437) 70,000 137,148,136

Options and warrants exercised for purchase of 661,700
shares of common stock, including income tax
benefit of $1,887,006 6,998,043
Issuance of 824,000 shares of common stock in connection
with the investment in Jostens Learning Corporation 21,218,000
Issuance of 116,605 shares of common stock in
connection with other acquisitions (291,420)
Exercise of underwriter's overallotment option to purchase
33,750 shares of common stock in connection with 1995
public stock offering 533,250
Foreign currency translation adjustment (74,131) (74,131)
Unrealized gain (loss) on available-for-sale securities (5,606) (5,606)
Net income for 1996 14,796,321
------------- -------------- ----------------

Balance at December 31, 1996 (11,043) (4,131) 180,322,593

Options and warrants exercised for purchase of 1,137,245
shares of common stock, including income tax
benefit of $8,155,946 13,119,475
Issuance of 357,143 shares of common stock in connection with
contingent consideration related to the acquisition of Drake 8,142,856
Issuance of 714,884 shares of common stock in connection
with the acquisition of WSI 15,320,131
Issuance of 269,118 shares of common stock to Sylvan
Learning Foundation as charitable contribution 6,541,000
Issuance of 205,882 shares of common stock to IT Training
Marketing Company as marketing expense 7,000,000
Issuance of 176,470 shares of common stock to SLC National
Advertising Fund, Inc. as advertising expense 5,000,000
Issuance of 2,062,292 shares of common stock for cash
- net of offering costs of $3,645,455 73,690,495
Capital contribution by former shareholders of Educational Inroads 2,810,930
Distributions to former shareholders of Educational Inroads (1,332,864)
Issuance of 62,562 shares of common stock in connection
with other acquisitions 718,697
Stock options to purchase 211,000 shares of common stock
granted to non-employees 550,000
Foreign currency translation adjustment (957,475) (957,475)
Unrealized gain (loss) on available-for-sale securities 11,043 11,043
Net income for 1997 29,433,999
------------- -------------- ----------------

Balance at December 31, 1997 $ - $ (961,606) $ 340,370,880
------------- -------------- ----------------


See accompanying notes.

33




SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended
December 31,
------------------------------------------------------
1995 1996 1997
------------------------------------------------------

OPERATING ACTIVITIES
Net income $ 3,571,331 $ 14,796,321 $ 29,433,999
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation 4,112,535 5,986,025 8,167,567
Amortization 4,323,351 7,478,485 10,051,655
Non-cash marketing and advertising expense - - 11,500,000
Interest imputed on purchase of Drake 1,125,000 - -
Loss on impairment of assets 3,315,541 - 4,000,000
Non-cash dividend income - - (2,000,000)
Provision for doubtful accounts (42,631) 55,738 540,888
Deferred income taxes (387,313) 2,105,914 1,878,471
Equity in net (income) loss of affiliates (390,692) (363,396) 2,131,240
Non-cash issuance of options to non-employees - - 550,000
Gain on sale of property and equipment - - (651,481)
Changes in operating assets and liabilities:
Accounts and notes receivable (10,780,236) (10,709,674) (26,417,871)
Cost and estimated earnings in excess of billings
on uncompleted contracts (1,021,779) (412,910) (136,823)
Inventory (1,561,091) (134,483) (300,148)
Prepaid expenses and other current assets (1,388,445) (273,711) (593,822)
Other assets (109,736) (997,608) (754,990)
Accounts payable and accrued expenses (3,132,695) 5,406,434 16,341,179
Billings in excess of costs and estimated earnings
on uncompleted contracts (455,600) (233,665) 120,350
Deferred revenue and other long-term liabilities 115,149 922,642 1,679,516
--------------- -------------- ---------------

Net cash provided by (used in) operating activities (2,707,311) 23,626,112 55,539,730
--------------- -------------- ---------------

INVESTING ACTIVITIES
Purchase of available-for-sale securities (91,759,493) (31,261,415) (92,521,520)
Proceeds from sale of available-for-sale securities 66,595,240 45,542,061 26,044,710
Investment in and advances to affiliates 286,872 (3,346,069) (9,260,478)
Increase in other investments - (2,329,874) (4,136,250)
Purchase of property and equipment (6,148,998) (13,580,617) (28,659,848)
Proceeds from sale of property and equipment - - 1,905,481
Purchase of contract rights - (4,890,576) -
Purchase of Drake Prometric, L. P., including direct costs of
acquisition, net of cash received (16,979,737) - -
Purchase of Wall Street Institute, including direct costs of
acquisition, net of cash received - 2,012,565 (4,670,565)
Cash paid for other acquired businesses, net of cash received 182,411 - (1,726,012)
Expenditures for deferred contract costs and other assets (801,586) (6,941,769) (1,443,058)
--------------- -------------- ---------------
Net cash used in investing activities (48,625,291) (14,795,694) (114,467,540)
--------------- -------------- ---------------
FINANCING ACTIVITIES
Payments on loans from stockholders of acquired companies (630,533) (37,604) (492,887)
Proceeds from exercise of options and warrants 4,218,256 5,111,037 4,963,529
Proceeds from issuance of common stock 44,132,734 533,250 73,690,495
Proceeds from issuance of long-term debt 346,195 154,414 -
Payments on long-term debt and capital lease obligations (2,867,459) (2,609,866) (5,323,852)
Proceeds from bank lines of credit 4,600,000 200,000 13,575,297
Payments on bank lines of credit - (3,812,069) (14,575,297)
--------------- -------------- ---------------
Net cash provided by (used in) financing activities 49,799,193 (460,838) 71,837,285
--------------- -------------- ---------------
Effects of exchange rate changes on cash 70,000 (74,131) (957,475)
--------------- -------------- ---------------

Net increase (decrease) in cash and cash equivalents (1,463,409) 8,295,449 11,952,000
Cash and cash equivalents at beginning of period 4,366,066 2,902,657 11,198,106
--------------- -------------- ---------------

Cash and cash equivalents at end of period $ 2,902,657 $ 11,198,106 $ 23,150,106
=============== ============== ===============


See accompanying notes.

34


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1. BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS

Sylvan Learning Systems, Inc. and subsidiaries (the Company) is an international
provider of educational and testing services. The Company conducts operations
in three separate business segments - core educational services, testing
services, and contract educational services. The core educational services
segment designs and delivers individualized tutorial services to school-age
children and adults through a network of 670 franchised and Company-owned Sylvan
Learning Centers in operation in 49 states, five Canadian provinces, Hong Kong,
Guam and South Korea. The Company's testing segment ("Sylvan Prometric")
administers computer-based tests for major corporations, professional
associations and governmental agencies through a network of certification
centers which are located throughout the world. This segment also includes the
operations of Wall Street Institute, a European-based franchisor and operator of
learning centers that teach the English language through a combination of
computer-based and live instruction. The contract educational services segment
provides educational programs to employees of large corporations and to public
and non-public school districts through contracts funded by federal Title I and
state-based programs.


The consolidated financial statements include the accounts of Sylvan Learning
Systems, Inc. and its wholly-owned subsidiaries. All intercompany accounts and
transactions have been eliminated in consolidation. Investments in affiliates
owned more than 20%, but not in excess of 50%, and corporate joint ventures are
reported using the equity method.

The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts and related disclosures. Actual
results could differ from those estimates.

As discussed in Note 3, On May 30, 1997, the Company consummated its acquisition
by merger of all of the outstanding stock of I-R, Inc. and Independent Child
Study Teams, Inc. (collectively, "Educational Inroads"). The acquisition has
been accounted for as a pooling-of-interests and accordingly, the Company's
financial statements have been restated to include the results of Educational
Inroads for all periods presented.


2. ACCOUNTING POLICIES

Cash Equivalents

The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.

35


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


2. ACCOUNTING POLICIES (CONTINUED)

Investments

Available-for-sale securities are carried at fair value, with the unrealized
gains and losses, net of tax, reported in a separate component of stockholders'
equity. The amortized cost of debt securities in this category is adjusted for
amortization of premiums and accretion of discounts to maturity. Such
amortization is included in investment income. Realized gains and losses and
declines in value judged to be other than temporary on available-for-sale
securities are included in investment income. The cost of securities sold is
based on the specific identification method. Interest and dividends on
securities classified as available-for-sale are included in investment income.

Inventory

Inventory, consisting primarily of computer software and educational,
instructional, and marketing materials and supplies, is stated at the lower of
cost (first-in, first-out) or market value.

Property and Equipment

Property and equipment is stated at cost. Depreciation is determined using the
straight-line method over the estimated useful lives of the assets.

Intangible Assets

Goodwill consists of the cost in excess of fair value of the net assets of
entities acquired in purchase transactions, and is amortized on a straight-line
basis, over the estimated future periods to be benefited, which range from 10 to
25 years. At December 31, 1996 and 1997, accumulated amortization of goodwill
was $4,803,586 and $8,723,689, respectively.

Contract rights consist of the allocated cost of acquiring computer-based
testing contracts in business combinations accounted for as purchases.
Contract rights are being amortized on a straight-line basis, over the term of
the related contract, which range from nine months to 10 years. At December 31,
1996 and 1997, accumulated amortization of contract rights was $5,193,199 and
$6,898,966, respectively.

36


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


2. ACCOUNTING POLICIES (CONTINUED)

Deferred Contract Costs

Deferred contract costs include costs incurred to develop computer-based tests
under contractual arrangements with customers. Under these arrangements, the
Company incurs certain costs related to the development of new computer-based
tests on behalf of the customer in return for the right to deliver the computer-
based tests and collect a testing fee from either the candidate or the
sponsoring organization. These costs are capitalized and amortized over the
shorter of the estimated utility period of the test or the contractual period
for delivery of the test.

Deferred contract costs also include payments of approximately $10,400,000 made
to non-affiliated computer-based testing centers that have entered into three-
year contracts with the Company to deliver information technology computer-based
certification tests. In accordance with the terms of these contracts, the
independent testing centers have received an advance payment and will receive no
additional fees upon delivery of the computer-based certification tests. These
costs are being amortized over the contractual term of three years.

Impairment of Long-Lived Assets

Long-lived assets, including intangible assets, are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be fully recoverable. If an impairment indicator is present,
the Company evaluates whether an impairment exists on the basis of undiscounted
expected future cash flows from operations for the remaining amortization
period. If an impairment exists, the asset is reduced by the estimated
shortfall of discounted cash flows.


Revenue Recognition

Franchise sales fees relate to single-center and area franchise sales. Revenue
related to these sales is recognized when all material services or conditions
relating to the sales have been substantially performed or satisfied by the
Company. For single-center franchise sales, the criteria for substantial
performance include: (1) receipt of an executed franchise license agreement,
(2) receipt of full payment of the franchise fee, (3) completion of requisite
training by the franchisee or center director, and (4) completion of site
selection assistance and site approval. Area franchise sales generally transfer
to the licensee the right to develop and operate centers in a specified
territory, primarily in a foreign country, and the Company's future obligations
are insignificant. Area franchise fees are recognized upon the signing of the
license agreement and the determination that (1) all material services or
conditions relating to the sale have been satisfied and the fee is non-
refundable, (2) a minimum payment of 50% of the fee is required within 90 days
of the date of the agreement, and (3) the Company has the ability to estimate
the collectability of any unpaid

37


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


2. ACCOUNTING POLICIES (CONTINUED)

amounts. Franchise sales fees not meeting the recognition criteria are recorded
as deferred revenue if not refundable, or deposits from franchisees if
refundable. Commissions paid on sales of franchises are recorded as a current
asset until the corresponding revenue is recognized.

Fixed price contracts with school districts receiving funds under the federal
Title I program and state-based programs are accounted for using the percentage-
of-completion method. Income is recognized based on the percentage of contract
completion determined by the total expenses incurred to date as a percentage of
total estimated expenses at the completion of the contract. Total contract
income is estimated as contract revenue less total estimated costs considering
the most recent cost information. Revenues from cost-plus-fee contracts are
recognized on the basis of costs incurred during the period plus the fee earned.

Franchise royalties are reported as revenue as the royalties are earned and
become receivable, unless collection is not reasonably assured. Revenues from
educational services are recognized in the period the services are provided.

Revenue from the sale of products to franchisees is recognized when shipped.
Testing revenues are recognized upon the completion of tests.

Stock Options Granted to Employees and Non-Employees

The Company records compensation expense for all stock-based compensation plans
using the intrinsic value method prescribed by APB Opinion 25, Accounting for
Stock Issued to Employees ("APB No. 25"). Under APB No. 25, if the exercise
price of the Company's employee stock options equals the estimated fair value of
the underlying stock on the date of grant, no compensation expense is generally
recognized. Statement of Financial Accounting Standards No. 123, Accounting
for Stock-Based Compensation ("Statement No. 123") encourages companies to
recognize expense for stock-based awards based on their estimated fair value on
the date of grant. Statement No. 123 requires disclosure of pro forma income
and earnings per share data in the notes to the financial statements if the fair
value method is not elected. The Company accounts for its stock-based
compensation plans using the intrinsic value method, and supplementally
discloses in Note 13 to these financial statements the pro forma information as
if the fair value method has been adopted.

The Company records compensation expense for all stock options granted to non-
employees in an amount equal to the estimated fair value at the date of grant,
determined using the Black-Scholes option valuation model. The compensation
expense is recognized over the vesting period.

38


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


2. ACCOUNTING POLICIES (CONTINUED)

Foreign Currency Translation

The financial statements of certain foreign subsidiaries that are measured in
local functional currencies have been translated into U.S. dollars using the
current rate method. All balance sheet accounts have been translated using the
rates of exchange at the balance sheet date. Results of operations have been
translated using the average rates prevailing throughout the year. Translation
gains or losses resulting from the changes in exchange rates from year to year,
are accumulated as a separate component of stockholders' equity.

The financial statements of other foreign subsidiaries, primarily those
subsidiaries providing services overseas to Educational Testing Services, Inc.
("ETS") (see Note 19), prepare financial statements using the U.S. dollar as the
functional currency. The transactions of these subsidiaries that are
denominated in foreign currencies have been remeasured in U.S. dollars. Any
resulting gain or loss is recorded as an adjustment of the amount due from ETS
as the contract with ETS requires ETS to bear the risk of realized translation
gains or losses.

Pending Adoption of New Accounting Standards

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, Reporting Comprehensive Income
("Statement No. 130"), that establishes standards for the reporting and display
of comprehensive income and its components in the Company's general-purpose
financial statements. Statement No. 130 only impacts display as opposed to
actual amounts recorded. Other comprehensive income includes all non-owner
changes in equity that are excluded from net income, such as foreign currency
translation adjustments and unrealized gains and losses on the Company's
available-for-sale securities. Statement No. 130 is effective for financial
statements issued for fiscal years beginning after December 15, 1997. The
Company will adopt this standard in 1998.

In December, 1997 the Accounting Standards Executive Committee of the AICPA
issued a proposed Statement of Position ("SOP"), "Reporting on the Costs of
Start-Up Activities." The proposal would be effective for fiscal years
beginning after December 15, 1997. The SOP as proposed would require that all
costs associated with start-up activities, including one-time activities related
to opening a new facility, introducing a new product or service and any
organizational costs, be charged to expense as incurred. The Company will
record the effect of adopting this SOP as a cumulative effect of a change in
accounting principle in the year the SOP is adopted. The Company has concluded,
after a preliminary review, that the adoption of the SOP will require a
cumulative effect charge of between $4.0 million and $5.0 million.

39


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


2. ACCOUNTING POLICIES (CONTINUED)

Reclassifications

Certain amounts in the 1995 and 1996 consolidated financial statements have been
reclassified to conform with the 1997 presentation.

3. ACQUISITIONS

NAI/Block Acquisition

Effective December 1, 1997, the Company purchased the assets and liabilities of
Block Testing Services L.P. and Block State Testing Services L.P. and also
acquired all of the outstanding stock of National Assessment Institute, Inc.,
(collectively "NAI/Block"), commonly controlled companies engaged in the
business of designing, marketing, selling, distributing and administering paper
and pencil tests and the licensing of individuals. The acquisition, which will
be paid by issuing 642,901 shares of common stock valued at $24.6 million, was
accounted for using the purchase method of accounting.

The results of operations of NAI/Block for the month of December 1997 are
included in the accompanying 1997 consolidated statement of income. Goodwill of
$28.9 million related to the acquisition is being amortized over its estimated
useful life of 25 years.


I-R, Inc. and Independent Child Study Teams, Inc.

On May 30, 1997, the Company acquired by merger all of the outstanding stock of
I-R, Inc. and Independent Child Study Teams, Inc. (collectively, "Educational
Inroads") in exchange for 1,414,000 shares of common stock. I-R, Inc. and
Independent Child Study Teams, Inc. were commonly owned by two shareholders.

The acquisition was accounted for as a pooling of interests and accordingly, the
Company's consolidated financial statements for periods prior to the merger have
been restated to include the combined results of operations, financial position
and cash flows of Educational Inroads.

Educational Inroads provides remedial and special education services to public
and non-public school systems, with current contracts in New Jersey, Maryland,
Louisiana, Washington, D.C. and other school districts. Combined and separate
results of operations of Sylvan and Educational Inroads during the years prior
to the merger are as follows:

40


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


3. ACQUISITIONS (CONTINUED)



Previously Independent
Reported by Child Study
The Company I-R, Inc. Teams, Inc. Combined
------------ ---------- ----------- ------------

Year ended
December 31, 1996
Revenues $157,116,660 $9,825,299 $14,994,002 $181,935,961
Net income $ 14,743,106 $ 31,664 $ 21,551 $ 14,796,321
Earnings per common
share - diluted $ 0.64 $0.60

Year ended
December 31,1995
Revenues $ 87,990,818 $9,475,103 $13,592,629 $111,058,550
Net income $ 3,547,829 $ 16,882 $ 6,620 $ 3,571,331
Earnings per common
share - diluted $ 0.23 $0.21


Wall Street Institute International, B.V. and Affiliates

Effective December 1, 1996, the Company acquired substantially all of the
operating net assets of Wall Street Institute International, B.V. and its
commonly controlled affiliates (collectively, "WSI"). The Company recorded the
acquisition using the purchase method of accounting. WSI is a European-based
franchisor and operator of learning centers that teach the English language
through a combination of computer-based and live instruction. WSI has a network
of franchised centers in operation throughout Europe and Latin America.

The total purchase price of WSI of $21,071,000 consisted of cash of $4,921,000,
505,364 shares of restricted common stock valued at $9,250,000, 209,520 shares
of unrestricted common stock valued at $5,900,000 and $1,000,000 of direct
acquisition costs. The restricted stock may not be transferred by the sellers
for a period of three years from the date of issuance, unless the Company, in
its sole discretion, removes the restriction. Of the 505,364 shares of
restricted common stock issued to the sellers, 124,292 shares are held in escrow
to indemnify the Company against any subsequent losses resulting from any
misrepresentation or breach of certain covenants. The unrestricted common stock
held in escrow will be released in varying amounts to the sellers through 2001.

Goodwill of $19.9 million is being amortized over its estimated useful life of
25 years. The cash portion of the purchase price was recorded as a current
liability at December 31, 1996, and the portion of the purchase price
represented by common stock was recorded as a non-current liability

41


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


3. ACQUISITIONS (CONTINUED)

at December 31, 1996. Upon closing of the transaction in January 1997, the
Company paid the cash portion of the purchase price to the sellers and recorded
the issuance of 714,884 shares of common stock to the sellers as a reduction in
the noncurrent liability.

The Company on the closing date of the acquisition entered into option
agreements to purchase two franchisees of WSI, and granted the owners of these
same franchisees put rights that require, in certain circumstances and at the
election by the right holders, the Company to purchase the
franchisees. At the Company's option it may purchase the two franchisees at any
time during the period from September 1, 2001 through September 1, 2005 for an
amount equal to seven times the previous fiscal years' earnings before interest
and taxes, adjusted for certain defined items. The franchisees may require the
Company to purchase substantially all of their net assets during the same four-
year period if defined levels of operating results are met or exceeded at the
end of the most recently completed fiscal year. The purchase price is payable
10% in cash and 90% in common stock, or at the Company's option, entirely in
cash.

The PACE Group

Effective February 28, 1995, the Company purchased the assets and liabilities of
The PACE Group ("PACE"), a provider of educational services to corporations.
The initial consideration for the acquisition was 262,446 shares of common stock
having an aggregate market value of $3,160,861. The acquisition was accounted
for using the purchase method of accounting. Additional contingent
consideration is payable in an amount equal to 6.5 times PACE's earnings before
interest and income taxes (EBIT) in 1997 as elected by the sellers, determined
in accordance with generally accepted accounting principles. EBIT in 1997 was
$3,965,758, resulting in additional consideration of $25,777,427 payable in cash
of $14,469,000 and the remainder in shares of common stock. The Company has
recorded this additional consideration as a liability and increased goodwill,
and will amortize that amount over the remaining amortization period of 22
years.

Drake Prometric, L.P.

Effective September 30, 1995, the Company acquired Drake Prometric, L.P.
("Drake"), a Minneapolis based provider of computer-based certification,
licensure and assessment testing programs. As of that date, Drake had a
network of 820 testing centers on six continents, 472 of which were located in
North America and the remainder in 69 foreign countries.

42


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


3. ACQUISITIONS (CONTINUED)

The Company acquired Drake for an initial purchase price $70.6 million,
consisting of $20.0 million in cash and 5,714,286 restricted shares of common
stock (the "Initial Shares"). Of the Initial Shares, 1,785,714 shares (the
"Revenue Escrow Shares") were placed in escrow and will be released to the
sellers to the extent that certain revenue targets relating to portions of the
combined computer-based testing business are achieved from 1996 through 1998.
The sellers may receive up to an additional $40.0 million (payable 12.5% in cash
and the balance in either cash or restricted shares of common stock, at the
Company's option) to the extent other revenue targets relating to portions of
the combined computer-based testing business are achieved in 1998 or 1999 (with
the measuring year selected by the sellers). The acquisition was accounted for
using the purchase method of accounting.

Approximately $4.8 million of contract rights and $69.8 million of goodwill were
recorded. The contract rights are being amortized over their respective terms,
and no term exceeds five years. Goodwill is being amortized over 25 years, its
estimated useful life.

The Company will record the contingent consideration consisting of the 1,785,714
Revenue Escrow Shares and the additional contingent payment of up to $40.0
million when the contingencies are resolved and the additional consideration is
payable. Based on testing revenues earned by the Company in 1996 and 1997, 60%
of the Revenue Escrow Shares (1,071,429 shares) have been earned through
December 31, 1997. As of December 31, 1997, an additional $28.2 million of
goodwill which relates to the earned shares was recorded which will be amortized
over the remaining estimated useful life. The 714,286 Revenue Escrow Shares
earned in 1997 will be released to the sellers in 1998.

Remedial Education and Diagnostic Services, Inc. and READS, Inc.

On February 17, 1995, the Company acquired by merger all of the outstanding
stock of Remedial Education and Diagnostic Services, Inc. and READS, Inc.
(collectively, "READS") in exchange for 525,108 shares of common stock. The
acquisition was accounted for as a pooling of interests and accordingly, the
Company's financial statements for periods prior to the merger have been
restated to include the results of operations, financial position and cash flows
of READS.

READS is based in Philadelphia, Pennsylvania and provides remedial and education
services, psychological, diagnostic and counseling services, career awareness
training, and a variety of consulting services. Services are delivered under
contracts with school districts, county-wide educational agencies and
municipalities in the eastern United States.

43


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


4. AVAILABLE-FOR-SALE SECURITIES


The following is a summary of available-for-sale securities (cost approximates
fair value):



December 31,
------------------------
1996 1997
----------- -----------

Municipal securities funds $3,646,361 $ 8,200,000
Cash reserve fund -- 38,221,248
U.S. Treasury bills and notes 3,002,398 --
Municipal bonds 9,800,000 36,504,321
----------- -----------
$16,448,759 $82,925,569
=========== ===========


The Company has not had any significant realized or unrealized gains or losses
on its investments during the periods presented. As of December 31, 1997, the
Company has approximately $50.5 million of investments that mature within one
year, $4.9 million of investments that mature between one and five years, $6.7
million of investments that mature between six and 20 years and $20.8 million of
investments that mature beyond 20 years. These investments are classified as
current as the Company views its available-for-sale securities as available for
use in its current operations.

5. ACQUISITION OF CONTRACT RIGHTS

In 1996, the Company acquired the rights to provide computer-based tests on
behalf of the National Association of Securities Dealers, Inc. ("the NASD") for
a period of ten years. As part of the agreement, the Company assumed certain
lease obligations and acquired the fixed assets of approximately 50 testing
centers previously operated by the NASD. The Company paid the NASD $5,114,673,
of which $4,871,832 related to contract rights and $242,841 related to fixed
assets.

In 1997, the Company incurred an additional $1,243,691 of costs related to the
acquisition of contract rights from the NASD. The contract rights, are being
amortized over the contract life of ten years on a straight-line basis.

44


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


6. INVESTMENTS

Investments in Affiliates

At December 31, 1997 and 1996, the Company's investments in and advances to
affiliates consists primarily of its 10% voting interest in Caliber Learning
Network, Inc. ("Caliber"), including related loans. Caliber is a corporate
joint venture with MCI Communications Corp. formed for the purpose of providing
adults throughout the United States with university-quality continuing education
using multimedia technology.

The Company's investment in and advances to Caliber consisted of the following
at December 31:



1996 1997
------------------- --------------------

Invested capital $1,300,000 $ 3,935,642
Loans and related interest 1,212,800 3,361,674
Amounts due for management fee 480,000 2,880,500
---------- -----------
2,992,800 10,177,816
Allocable share of losses from inception (141,837) (1,500,842)
---------- -----------
$2,850,963 $ 8,676,974
========== ===========


Since its inception in 1996, Caliber relied almost entirely on the Company's
resources, systems, and personnel for administrative, management, accounting and
financial functions. In consideration for these services, the Company charged
Caliber $2,880,500, which is unpaid at December 31, 1997. This amount will
begin to accrue interest effective January 1, 1999 at the prime rate plus 1%,
and is payable in 48 equal monthly installments of principal and interest also
beginning January 1, 1999. If Caliber completes an initial public offering of
its common stock, all amounts are immediately due and payable. Caliber has
agreed to pay an annual management fee of $2.0 million in 1998 and 1999, due in
equal quarterly installments.

The Company has loaned to Caliber certain amounts under a line of credit that
bears interest at 1% above the prime rate as published by a defined commercial
bank. All amounts borrowed under the line of credit are due at the earliest of
the closing of an initial public offering of Caliber's common stock, or December
31, 2000.

During 1997, the Company assigned the leases for 32 testing centers to Caliber
for the use by Caliber in its operations. Upon assignment of the centers,
Caliber assumed the revenue stream from the ongoing testing operations and paid
the Company a fee of $4.0 million to manage the continuing testing operations.

45


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


6. INVESTMENTS (CONTINUED)

The Company also maintains investments in other affiliates totaling $3,044,639
and $3,786,755 at December 31, 1996 and 1997, respectively. The Company's
allocable share of earnings (losses) related to these investments for the years
ended December 31, 1996 and 1997 was $505,233 and $(772,235), respectively.

Other Investments

Other investments consist of non-marketable investments in common and preferred
stocks of private companies in which the Company does not exercise significant
influence. These investments are carried at the lower of cost or estimated net
realizable value.

At December 31, 1996 and 1997, other investments consist primarily of a non-
voting convertible preferred stock investment in JLC Learning Corporation
("JLC"), a company that develops educational software products. The preferred
stock requires the payment of cumulative dividends in the annual amount of $2
million for two years totaling $4 million, which may be paid in additional
shares of preferred stock. At December 31, 1996 and 1997, the Company's
investment in JLC was $21.9 million and $24.0 million, respectively. During 1996
and 1997, the Company recorded dividend income from this investment in the
amount of $333,333 and $2,000,000, respectively, paid in the form of additional
preferred stock.

The Company also maintains other investments not readily marketable totaling
$0.3 million and $4.0 at December 31, 1996 and 1997, respectively.

7. BANK LINES OF CREDIT

The Company has entered into a loan agreement with a bank, (hereinafter, "the
credit line") that provides an unsecured revolving line of credit. The credit
line allows the Company to borrow a maximum of $15.0 million through the
expiration date of May 31, 1998, at which time the total outstanding principal
balance can be converted into a term loan, at the option of the Company. The
term loan would be repaid over 24 months from the time of issuance. The credit
line and the term loan both bear interest at a floating rate equal to the 30 day
London Interbank Offered Rate ("LIBOR") plus 1.15% per annum (6.96% at December
31, 1997). No amounts on the line of credit were outstanding at December 31,
1996 or December 31, 1997.

46


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


8. LONG-TERM DEBT

Long-term debt consists of the following:



December 31,
-------------------------
1996 1997
---------- ----------

Note payable to a bank, bearing interest at 1.10%
over the LIBOR (6.63% at December 31, 1996).
The loan was repaid in its entirety in 1997. $2,320,000 $ --

Other notes payable bearing interest
at rates ranging from 8% to 14%. 3,032,298 930,231
---------- ----------
5,352,298 930,231

Less: current portion of long-term debt 3,182,197 930,231
---------- ----------

Total long-term debt $2,170,101 $ --
========== ==========


47


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


9. DUE TO SHAREHOLDERS OF ACQUIRED COMPANIES

Due to shareholders of acquired companies consists of the following (see also
Note 3)



December 31,
--------------------------------------------------
1996 1997
-------------------- ----------------------

Amounts payable to former owners of NAI/Block, payable
in 642,901 shares of common stock in January 1998 $ - $ 25,000,000
Amounts payable to former shareholders of Educational
Inroads 3,232,884 -
Amounts payable to former shareholders of WSI in cash 4,920,565 262,285
Amounts payable to former shareholders of WSI, payable
in 714,884 shares of common stock in January 1997 15,150,115 -
Amounts payable to former shareholders of PACE in cash - 13,531,910
Amounts payable to former shareholders of PACE,
payable in common stock in April 1998 - 11,308,427
Amounts payable to former shareholders of Drake in
common stock (1996 - 357,143 shares; 1997 - 714,286
shares) 8,142,856 20,057,151
-------------------- ----------------------
31,446,420 70,159,773
Less: current portion (4,920,565) (13,794,195)
-------------------- ----------------------
$26,525,855 $ 56,365,578
==================== ======================


10. LEASES

The Company conducts all of its operations from leased facilities. These
facilities include the Company's corporate headquarters and other office
locations, warehouse space, certain testing sites, and Company-owned learning
centers. The terms of these leases are five years or less, with the exception
of the Company's corporate headquarters, which has a lease term of ten years,
and generally contain renewal options. The Company also leases certain
equipment under operating leases of 36 months or less. Future minimum lease
payments at December 31, 1997, by year and in the aggregate, under all non-
cancelable operating leases are as follows:




Years ending December 31:
1998 $ 6,831,220
1999 5,976,802
2000 5,316,800
2001 4,515,938
2002 4,357,077
Thereafter 11,195,371
-----------
$38,193,208
===========


48


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

10. LEASES (CONTINUED)

Rent expense for cancelable and non-cancelable leases was $4.0 million, $6.5
million and $8.2 million for the years ended December 31, 1995, 1996 and 1997,
respectively.

11. CONTINGENCIES

On November 18, 1996, ACT, Inc. filed suit against the Company alleging that the
Company violated federal antitrust laws and committed various state law torts in
connection with the operations of its computer-based testing operations and in
obtaining a testing services contract from the NASD. The Company believes the
grounds of the lawsuit are without merit and intends to defend the lawsuit
vigorously. Management is unable to predict the ultimate outcome of the
lawsuit, but believes that the ultimate resolution of the matter will not have a
material effect on consolidated financial position.

The Company is subject to other legal actions arising in the ordinary course of
its business. In management's opinion, the Company has adequate legal defenses
and/or insurance coverage with respect to the eventuality of such actions and
does not believe any settlement would materially affect the Company's financial
position.

12. FAIR VALUE OF FINANCIAL INSTRUMENTS

The fair value of the Company's financial instruments, which consist primarily
of cash and cash equivalents, accounts and notes receivable, available-for-sale
investments, accounts payable, due to shareholders of acquired companies (cash
portion), and short and long-term debt, approximate their carrying amounts
reported in the consolidated balance sheets.

It was not practical to estimate the fair value of the Company's other
investments because of the lack of quoted market prices of the underlying equity
securities and the inability to determine fair value without incurring excessive
costs. Management does not believe that the value of these investments have
been impaired.

49


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


13. STOCK OPTIONS AND WARRANTS

Stock Options

The Company has an Employee Stock Option Plan ("the Employee Plan") which
provides for the granting of stock options to purchase up to 3,800,000 shares of
common stock. All options granted under the Employee Plan vest ratably over a
five-year period and expire six years after date of grant. At December 31,
1997, options to purchase 3,753,199 shares of common stock have been granted
under the Employee Plan.

Under a Management Stock Option Plan ("Management Plan"), the Company has
outstanding stock options at December 31, 1997 to purchase 160,850 shares of
common stock for $11.25 per share. All outstanding options are fully vested,
and expire on December 1, 2001. No additional options may be granted under the
Management Plan.

In March 1996, the Company established the Senior Management Stock Option Plan
("the Senior Management Plan") to replace the Management Plan. The Senior
Management Plan provides for the granting of stock options to purchase up to
2,250,000 shares of common stock. At December 31, 1997, options to purchase
1,035,000 shares of common stock have been granted under the Senior Management
Plan. Options granted under this plan expire ten years after the date of grant.
Of this amount, options for 165,000 shares became immediately vested, with the
balance vesting ratably over three years.

In October 1993 the stockholders approved the establishment of the Director
Stock Option Plan ("Director Plan") for all non-employee members of the Board of
Directors. Under the Director Plan, options to purchase 172,500 shares of
common stock may be issued to certain members of the Board of Directors. No
individual is eligible to receive more than 33,750 options under this plan and
options granted under this plan expire at varying times three months after a
director ceases his term on the Board. At December 31, 1997, options to purchase
168,750 shares of common stock have been granted under the Director Plan.

During 1997, the Company established the Sylvan Technology Center Stock Option
Plan ("the STC Plan") for the franchisee owners of Sylvan Technology Centers.
The STC Plan provides for the granting of stock options to purchase up to
300,000 shares of common stock. During 1997, 211,000 options were granted that
vest ratably over a three-year period and expire 10 years after the date of
grant or on the date of cessation of operations of the center. The fair value
of these options, determined using the Black-Scholes option valuation model, was
$1,386,000, of which $550,000 of expense was recognized in 1997, with the
remainder to be recognized in expense over the next three years as the options
vest.

50


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


13. STOCK OPTIONS AND WARRANTS (CONTINUED)

The following table summarizes the stock option activity of the Company.



1995 1996 1997
---------------------------------------------------------------------------------
Weighted Weighted
Average Average
Options Options Exercise Price Options Exercise Price
---------------------------------------------------------------------------------

Outstanding - beginning of year 2,574,731 3,235,151 $ 7.69 4,614,013 $13.06
Granted 919,083 1,847,875 21.92 1,142,402 35.59
Exercised (258,663) (384,563) 10.87 (1,080,542) 4.38
Forfeited - (84,450) 11.24 (52,482) 17.74
---------------------------------------------------------------------------------
Outstanding - end of year 3,235,151 4,614,013 $13.06 4,623,391 $20.63
=================================================================================
Exercisable at end of year 1,495,502 1,792,312 $ 6.67 1,794,118 $12.77
=================================================================================
Weighted-average fair value of
options granted during the year $ 8.33 $10.73
====== ======


Exercise prices for options outstanding as of December 31, 1997 ranged from
$5.22 to $43.88 as follows:




WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE REMAINING EXERCISE
PRICES OF CONTRACTUAL PRICES OF
RANGE OF OPTIONS OPTIONS LIFE OF OPTIONS OPTIONS OPTIONS
EXERCISE PRICES OUTSTANDING OUTSTANDING OUTSTANDING EXERCISABLE EXERCISABLE
- ------------------------------------------------------------------------------------------------------

$5.22-$9.12 1,032,750 $6.46 2.0 811,095 $6.41
- ------------------------------------------------------------------------------------------------------
$10.17-$17.00 644,034 13.13 3.7 368,902 12.55
- ------------------------------------------------------------------------------------------------------
$20.33-$29.66 2,158,607 23.04 6.7 614,121 21.30
- ------------------------------------------------------------------------------------------------------
$33.53-$43.88 788,000 38.45 5.8 - -
- ------------------------------------------------------------------------------------------------------


For the years ended December 31, 1996 and 1997, pro forma net income and
earnings per share information required by Statement 123 has been determined as
if the Company had accounted for its stock options using the fair value method.
The fair value of these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted average
assumptions for 1996 and 1997: risk-free interest rate of 6.00%, dividend yield
of 0%, volatility factors of the expected market price of the Company's common
stock of .399 and .280, respectively, and an expected life of granted options
which varies from zero to five years depending upon the vesting period.

The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option

51


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


13. STOCK OPTIONS AND WARRANTS (CONTINUED)

valuation models require the input of highly subjective assumptions including
the expected stock price volatility. Because the Company's stock options have
characteristics significantly different from those of traded options and because
changes in the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its stock options.

For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting periods. The Company's pro
forma information follows:



1995 1996 1997
- ---------------------------------------------------------------------------------------------------------------------

Pro forma net income $2,674,761 $11,938,549 $26,006,873
- ---------------------------------------------------------------------------------------------------------------------
Pro forma earnings per share:
- ---------------------------------------------------------------------------------------------------------------------
Basic $0.18 $0.52 $0.97
- ---------------------------------------------------------------------------------------------------------------------
Diluted $0.17 $0.49 $0.92
- ---------------------------------------------------------------------------------------------------------------------


The effect of compensation expense from stock options on 1995 pro forma net
income reflects only the vesting of 1995 awards. However, 1996 and 1997 pro
forma net income reflects additional years of vesting of the prior year awards
and the first year of vesting of current year awards. Because the granted stock
options vest over periods ranging from zero to five years, not until 2001 is the
full effect of recognizing compensation expense for stock options representative
of the possible effects on pro forma net income for future years.

Stock Warrants

In July 1993 warrants to purchase 239,364 shares of common stock for $5.22 per
share were issued in connection with a $5.0 million financing. Warrants to
purchase 136,728, 54,457 and 4,790 shares of common stock were exercised in
1995, 1996 and 1997, respectively. The remaining 38,601 warrants expire in July
1998.

14. IMPAIRMENT LOSS


In September 1995, the Company determined that certain assets of Sylvan
Prometric were impaired as a result of the acquisition of Drake. These assets,
consisting of computer equipment, software and other assets, were impaired
because of dissimilar technical requirements for Drake computer-based tests, or
because their use was limited by virtue of the acquisition of similar productive
assets from Drake. The amount of the impairment loss was determined by
evaluating the likely sales proceeds from the disposition of the assets as
compared to their book value.

52


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


14. IMPAIRMENT LOSS (CONTINUED)

In May 1997, the Company determined that certain assets of Sylvan Prometric were
impaired as a result of certain strategic changes that were made as a result of
pursuing the National Education Corporation ("NEC") acquisition (see Note 15).
During and after the acquisition negotiations with NEC, the Company developed
certain plans that resulted in required changes in both software systems and
hardware currently utilized in Sylvan Prometric's network of centers. The plans
continued to be valid for the Company even after the NEC acquisition was
terminated. The impaired assets, consisting of computer equipment and software,
were impaired as a result of changes in the technical requirements and
specifications of certain computer hardware and software. The amount of the
impairment loss was determined by evaluating the likely sales proceeds from the
disposition of the assets compared to their book value. The Company determined
that it was unlikely that the net cash proceeds from the sale of any assets
would be significant, and therefore recorded an impairment loss equal to the net
book value of the assets of $4.0 million.

15. TERMINATION FEE

In March 1997, the Company and NEC executed a definitive agreement pursuant to
which the Company was to acquire NEC. In May 1997, NEC accepted the offer of
Harcourt General, Inc. to acquire all of the stock of NEC which resulted in the
termination of NEC's agreement with the Company and NEC's payment to the
Company of the $30.0 million termination fee required by that agreement. The
Company also incurred $1.5 million of expenses in connection with the NEC
transaction, and reported the net termination fee of $28.5 million in 1997.

16. CONTRIBUTIONS

During 1997, the Company made certain cash expenditures and common stock
contributions resulting in an aggregate expense to the Company of approximately
$21.5 million. The $21.5 million, recorded as operating expenses, was
attributable to contributions of (i) $3.0 million in cash and common stock
valued at $7.0 million to IT Training Marketing Company, a nonprofit corporation
whose sole purpose is to fund promotional and channel support programs for the
Sylvan Prometric distribution channel, (ii) common stock valued at $5.0 million
to SLC National Advertising Fund, Inc., a nonprofit corporation whose sole
purpose is to develop and fund advertising programs for the Sylvan Learning
Centers and (iii) common stock valued at $6.5 million to Sylvan Learning
Foundation, a nonprofit foundation formed to promote various educational
pursuits.

53


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


17. Income Taxes

Significant components of the provision for income taxes are as follows:



Year ended December 31,
------------------------------------
1995 1996 1997
--------- ---------- -----------


Current:
Federal $ 250,334 $4,991,497 $ 8,972,231
Foreign 133,887 372,996 940,670
State 212,251 1,379,593 1,547,450
--------- ---------- -----------
Total current 596,472 6,744,086 11,460,351
Deferred (benefit):
Federal (300,168) 1,773,051 3,441,592
Foreign - - 306,446
State (87,145) 332,863 855,611
--------- ---------- -----------
Total deferred (387,313) 2,105,914 4,603,649
--------- ---------- -----------
Total provision $ 209,159 $8,850,000 $16,064,000
========= ========== ===========


For the years ended December 31, 1996 and 1997, foreign income before income
taxes was approximately $2.9 million and $12.6 million, respectively.

The Company uses the liability method to account for income taxes. Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amount of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes.

54


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


17. INCOME TAXES (CONTINUED)


Significant components of the Company's deferred tax assets and liabilities are
as follows:



Year ended December 31,
-------------------------
1996 1997
----------- -----------

Deferred tax assets:
Net operating loss carryforwards $ 2,277,600 $ 765,153
Loss on impairment of assets 71,601 779,429
Deferred revenue 443,618 629,659
Allowance for doubtful accounts 301,205 548,046
Advertising costs - 5,304,604
Amortization of intangible assets 459,040 642,977
Equity share of losses from affiliates 53,841 827,089
Charitable contribution carryforward 23,746 2,424,881
Tax credit carryforwards 76,544 925,844
Other 168,780 538,509
----------- -----------
Total deferred tax assets 3,875,975 13,386,191

Deferred tax liabilities:
Deferred contract costs 1,746,807 2,066,448
Contract rights 316,619 169,586
Depreciation 684,508 1,470,612
Deferred income - 11,388,000
Accrued receivables 266,432 558,646
Other 302,610 564,818
----------- -----------
Total deferred tax liabilities 3,316,976 16,218,110
----------- -----------
Net future income tax benefit (liability) 558,999 (2,831,919)
Valuation allowance for net deferred
tax assets (2,277,600) (765,153)
----------- -----------
Net deferred tax liabilities $(1,718,601) $(3,597,072)
=========== ===========


The net operating loss carryforwards at December 31, 1997 are related to a
subsidiary of the Company, and are available only to offset future taxable
income of the subsidiary. These net operating loss carryforwards will begin to
expire in 2007.

55


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


17. INCOME TAXES (CONTINUED)

The reconciliation of the reported income tax expense to the amount that would
result by applying the U.S. federal statutory tax rates to income before income
taxes is as follows:



Year ended December 31,
--------------------------------------
1995 1996 1997
----------- ---------- -----------

Tax expense at U.S. statutory rate $ 1,277,000 $8,022,000 $15,469,000
Permanent differences 828,000 813,000 2,120,000
State income tax expense, net of
federal tax effect 123,000 1,130,000 1,555,000
Tax effect of foreign income taxed at lower rate (87,000) (704,000) (3,556,000)
Change in valuation allowance affecting
tax expense (2,026,000) - -
Utilized tax credits - (254,000) -
Other 94,000 (157,000) 476,000
----------- ---------- -----------
$ 209,000 $8,850,000 $16,064,000
=========== ========== ===========


18. EARNINGS PER SHARE

In 1997, the Financial Accounting Standards Board issued Statement No. 128,
Earnings Per Share ("Statement No. 128"). Statement No. 128 replaced the
calculation of primary and fully diluted earnings per share with basic and
diluted earnings per share. Unlike primary earnings per share, basic earnings
per share excludes any dilutive effects of options, warrants and convertible
securities. Diluted earnings per share is very similar to the previously
reported fully-diluted earnings per share. Earnings per share amounts for all
periods have been presented, and where appropriate, restated, to conform to the
Statement No. 128 requirements.

The following table summarizes the computations of basic and diluted earnings
per share:

56



SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


18. EARNINGS PER SHARE (CONTINUED)



Year ended December 31,
-------------------------------------
1995 1996 1997
----------- ----------- -----------

Numerator used in basic and diluted
earnings per common share:
Net income $ 3,571,331 $14,796,321 $29,433,999
=========== =========== ===========

Denominator:
Denominator for basic earnings per common
share weighted average shares 15,132,007 23,028,816 26,885,860

Effect of dilutive securities:
Employee stock options 1,851,103 1,379,485 1,233,256
Common stock contingently issuable 95,693 178,176 418,878
----------- ----------- -----------

Total dilutive potential common shares 1,946,796 1,557,661 1,652,134
----------- ----------- -----------

Denominator for diluted earnings per common
share weighted average shares and
assumed conversions 17,078,803 24,586,477 28,537,994
=========== =========== ===========

Earnings per common share, basic $ 0.24 $ 0.64 $ 1.09

Earnings per common share, diluted $ 0.21 $ 0.60 $ 1.03


The Company as of December 31, 1997 has reserved 6,019,179 shares of common
stock for future issuance upon the exercise of all outstanding stock purchase
warrants, the exercise of all outstanding stock options and the issuance of
shares of common stock in connection with purchase business combinations.

19. MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK

In 1997, the Company extended its agreement with Educational Testing Services
("ETS") to be the exclusive commercial provider of ETS domestic computer-based
tests through the year 2006. The contract to provide international computer-
based tests runs through the year 2004. The international testing contract with
ETS stipulates that the Company will be compensated for its services for a fee
equal to approved costs plus 10 percent, and the company recognizes revenues
accordingly. Operating costs under the contract will be paid at cost plus 10
percent on a monthly basis by ETS. Start-up costs will be paid ratably over a
period not to exceed 10 years. Total revenues from ETS represented
approximately 16.2%, 10.8% and 17.5% of consolidated revenues

57


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


19. MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK (CONTINUED)

for the years ended December 31, 1995, 1996 and 1997, respectively. The testing
business acquired from Drake in September 1995 is highly concentrated with two
customers. These customers contributed approximately 23% and 16% to consolidated
revenues for the years ended December 31, 1996 and 1997, respectively. The
Company expects the contracts with these two customers to be renewed at the
expiration date of the current contracts. The failure of these contracts to be
renewed under similar terms would have a detrimental effect on future operating
results and significantly impair the Company's ability to recover the remaining
goodwill balance of approximately $91.6 million related to the acquisition of
Drake.

Financial instruments which potentially subject the Company to credit risk are
investments in available-for-sale securities, accounts receivable and notes
receivable. The Company maintains an allowance for losses on receivables based
on the collectibility of all amounts owed. The Company generally does not
require collateral for trade receivables. Notes receivable are generally
collateralized by assets of the debtors. At December 31, 1997, the Company does
not have any significant concentrations of credit risk.

20. DEFINED CONTRIBUTION RETIREMENT PLAN

The Company sponsors a defined contribution retirement plan under section 401(k)
of the Internal Revenue Code. The provisions of this plan allow for voluntary
employee contributions, subject to certain annual limitations, and discretionary
Company contributions which are allocated to eligible participants based upon
compensation. All employees are eligible after meeting certain service
requirements. The Company made a discretionary contribution to this plan in
1997 of $248,000.

21. BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, Disclosures about Segments of an
Enterprise and Related Information ("Statement 131"). Statement 131 supercedes
Financial Accounting Standards Board Statement No. 14, Financial Reporting for
Segments of a Business Enterprise ("Statement 14"), and establishes new
standards for the way that public enterprises report selected information about
operating segments in annual and interim financial statements. It also
established standards for related disclosures about products and services,
geographical areas, and major customers. Statement 131 is effective for
financial statements issued for fiscal years beginning after December 31, 1997.
The Company has elected to adopt this statement in 1997, and accordingly, the
disclosures for all periods have been presented, and where appropriate, restated
to conform to the Statement 131 requirements.

58


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


21. BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION (CONTINUED)

Description of Services From Which Each Reportable Segment Derives its Revenues

The Company provides lifelong educational services through three distinct
operating segments. The Sylvan Learning Centers division provides personalized
instructional services to students of all ages and skill levels, through its
network of franchised and Company-owned learning centers located in 49 states,
five Canadian provinces, Hong Kong, Guam and South Korea. The Sylvan Contract
Educational Services division provides educational services and professional
development to children and adults through contracts with school systems and
other organizations. These services to children are delivered at over 500
schools and in the case of its professional development services for adults, at
the contracting parties' facilities. The Sylvan Prometric division delivers
computer-based testing for academic admissions and professional certification
programs through a network of computer testing centers located throughout the
world, and includes the operations of Wall Street Institute, a European-based
franchisor and operator of learning centers for English language instruction
that will administer certain computer-based testing programs throughout Europe
and Latin America.

Measurement of Segment Profit or Loss and Segment Assets

The Company evaluates performance and allocates resources based on operating
income before corporate general and administrative expenses and income taxes.
The accounting policies used by the reportable segments are the same as those
used by the Company as described in Note 2 to the consolidated financial
statements. There are no significant intercompany sales or transfers.

Factors Management Uses to Identify the Company's Reportable Segments

The Company's reportable segments are business units that offer distinct
services. The segments are managed separately as they have different customer
bases and delivery channels.

The following table sets forth information on the Company's reportable segments:



Year Ended December 31, 1995
------------------------------------------------------------------------
Contract
Learning Centers Educational Services Sylvan Prometric
--------------------------- -------------------------- ----------------

Revenues $26,063,191 $50,429,662 $ 34,565,697
Depreciation and amortization 895,430 1,584,352 5,601,471
Loss on impairment of assets - - 3,315,541
Segment profit 7,387,957 2,745,082 901,873
Segment assets 12,863,792 26,568,393 98,200,486


59


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


21. BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION (CONTINUED)



Year Ended December 31, 1996
-------------------------------------------------------------------------
Contract
Learning Centers Educational Services Sylvan Prometric
--------------------------- -------------------------- ----------------

Revenues $36,799,287 $58,185,985 $ 86,950,689
Depreciation and amortization 945,968 1,939,778 9,911,562
Segment profit 11,242,406 4,812,800 15,432,208
Segment assets 13,967,337 27,495,706 153,657,895


Year Ended December 31, 1997
-------------------------------------------------------------------------
Contract
Learning Centers Educational Services Sylvan Prometric
--------------------------- -------------------------- ----------------

Revenues $44,289,019 $66,582,280 $135,340,434
Depreciation and amortization 672,831 1,613,686 14,115,516
Loss on impairment of assets - - 4,000,000
Unusual Items - contribution to
marketing fund - - 10,000,000
Significant non-cash charges
(advertising) 5,000,000 - -
Segment profit 7,580,158 10,525,659 17,484,961
Segment assets 21,843,781 57,064,257 252,724,879


The following tables reconcile the reported information on segment profit and
assets to income before income taxes and total assets reported in the
statements of income and balance sheets, respectively, for the years ended
December 31, 1995, 1996 and 1997:



1995 1996 1997
------------ ------------ -------------

Operating Profit:

Total profit for
reportable segments $11,034,912 $31,487,414 $ 35,590,778
Corporate general and
administrative expense (6,205,480) (8,755,406) (20,467,883)
Other income (expense),
net of direct costs (1,048,942) 914,313 30,375,104
----------- ----------- ------------

Income before income taxes $ 3,780,490 $23,646,321 $ 45,497,999
=========== =========== ============


60



SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


21. BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION (CONTINUED)



1995 1996 1997
------------ ------------ ------------

Assets:

Segment assets $137,632,671 $195,120,938 $331,632,917
Cash and available for sale
securities - corporate 33,637,176 27,381,251 86,630,693
Deferred tax asset 1,271,925 619,553 3,737,831
Property, plant and
equipment - Corporate 1,007,488 5,249,080 6,809,758
Investments in and advances
to affiliates 182,320 5,895,602 12,463,729
Other investments 338,681 22,219,888 28,017,457
Other non-segment assets - 3,103,209 4,223,179
------------ ------------ ------------

Total assets $174,070,261 $259,589,521 $473,515,564
============ ============ ============


Included in corporate general and administrative expense for the year ended
December 31, 1997 was a contribution of the Company's common stock valued at
$6.5 million as discussed in Note 16 to these financial statements.

Depreciation expense in the amounts of $0.4 million, $0.7 million and $1.8
million were charged to corporate departments during the years ended
December 31, 1995, 1996 and 1997, respectively.

Enterprise-Wide Disclosures - Information on Geographic Areas

Year Ended December 31, 1995
------------------------------

Revenues Long-lived Assets

United States $100,373,442 $ 99,099,102
Foreign countries - total 10,685,108 5,608,754
------------ ------------

Consolidated total $111,058,550 $104,707,856
============ ============

Year Ended December 31, 1996
------------------------------

Revenues Long-lived Assets

United States $152,912,824 $128,218,844
Foreign countries - total 29,023,137 23,743,870
------------ ------------

Consolidated total $181,935,961 $151,962,714
============ =================

61


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


21. BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION (CONTINUED)

Year Ended December 31, 1997
----------------------------------

Revenues Long-lived Assets

United States $188,796,500 $213,901,811
Foreign countries - total 57,415,233 29,325,319
------------ ------------

Consolidated total $246,211,733 $243,227,130
============ ============

Revenues from individual foreign countries did not exceed 10% of consolidated
revenues in any of the years presented. Long-lived assets domiciled in
individual foreign countries did not exceed 10% of consolidated long-lived
assets in any of the years presented. Note 19 to the financial statements
contains information about major customers of the Company.

22. SUPPLEMENTAL CASH FLOW INFORMATION

Interest payments were $2.4 million, $1.1 million and $0.5 million for the years
ended December 31, 1995, 1996 and 1997, respectively. The 1995 amount includes
imputed interest payments of $1.1 million related to the acquisition of Drake.

Income tax payments were $1.8 million, $4.0 million and $2.3 million for the
years ended December 31, 1995, 1996, and 1997, respectively.

62


SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


23. QUARTERLY FINANCIAL DATA (UNAUDITED)



Quarter ended
---------------------------------------------------
March 31, June 30, September 30, December 31,
1997 1997 1997 1997
--------- -------- ------------- ------------
(Amounts in thousands, except per share data)

Operating revenues $51,944 $ 57,596 $58,464 $78,210
Operating expenses 46,591 71,844 46,677 60,978
Loss on impairment of assets -- 4,000 -- --
------- -------- ------- -------

Operating income (loss) 5,353 (18,248) 10,787 17,232

Non-operating items, net 352 28,899 793 330
------- -------- ------- -------

Income before income taxes 5,705 10,651 11,580 17,562
Income taxes (2,258) (3,957) (4,053) (5,796)
------- -------- ------- -------

Net income $ 3,447 $ 6,694 $ 7,527 $11,766
======= ======== ======= =======

Net income per common share:
Basic $ 0.14 $ 0.26 $ 0.27 $ 0.41
======= ======== ======= =======
Diluted $ 0.13 $ 0.25 $ 0.26 $ 0.38
======= ======== ======= =======

Weighted average shares
outstanding:
Basic 25,379 25,499 27,746 28,956
======= ======== ======= =======
Diluted 27,251 27,109 29,255 31,345
======= ======== ======= =======


During the second quarter of 1997, the Company recognized an impairment loss of
$4.0 million, income from a termination fee of $28.5 million and recorded
expense related to contributions which totaled $21.5 million. These
transactions are described in Notes 14, 15 and 16, respectively.

The net effect of the above non-recurring items was an increase in pre-tax
income of $3.0 million and net income of $1.9 million, or $.07 per diluted
share.

Diluted earnings per common share for the year ended December 31, 1997 is $1.03.
The total diluted earnings per common share derived from the addition of the
quarterly amounts in 1997 is $1.02. This difference is caused by differences in
the estimated effect of contingently issuable shares related to the acquisition
of PACE in the quarterly periods as compared to the annual period.

63